Are ETFs better than index funds?

Some ETFs actually are index funds, so it depends how you look at it. If you're thinking of an index fund as your traditional unlisted investment fund, then both can be advantageous depending on how you use them. The benefit of choosing an ETF is you can invest smaller amounts more frequently and easily through a trading app. With an unlisted index fund, you often need $5,000 or more as a minimum investment and will need to go through an application process to add more funds or withdraw.

Is VAS an ETF or an index fund?

VAS is an ETF that passively tracks the ASX 300 index – so it's both an ETF and an index fund.

Can you lose money in an index fund?

Yes. Like all investments, index funds can go down in value depending on market performance.

Are ETFs riskier than index funds?

Some ETFs are index funds, which can be a relatively safe share market investment. However, some ETFs also use leverage or derivatives or track a single commodity, making them very high risk.

What's the main difference between ETFs and index funds?

An ETF is a product structure that trades like a stock. An index fund is a strategy that tracks a market index, and it can be delivered through an ETF or a traditional managed fund.

ETFs vs Index Funds in Australia: What’s the difference

ETFs and index funds can follow the same strategy, but they're not always the same thing.
ETFs are traded on the stock market in real-time; index funds are often bought directly from a fund manager.
An ETF is a type of investment product while an index fund describes the investment strategy.

It's one of the most common investing questions out there: What's the difference between an ETF and an index fund?

You'll often hear these terms used interchangeably, and that's not necessarily wrong, but it's not always right either. Sometimes an ETF is an index fund, sometimes it's not. And not all index funds are ETFs.

Confused? Don't worry – in this guide, we'll break down the key differences, how they work, how much they cost, and how you find one to suit your investing style.

How ETFs and index funds work

An index fund is an investment fund that tracks a specific index like the S&P/ASX 200 or S&P 500. It buys most or all the stocks in that index so your returns follow the market.

An ETF (exchange-traded fund) is a type of investment product that you can buy and sell on the stock exchange, just like a share. Many ETFs track an index (making them index funds) but some are actively managed or follow different strategies.

So while all index fund ETFs are ETFs, not all ETFs are index funds. Likewise, not all index funds are ETFs – some are traditional managed funds.

Sometimes you'll get the option to invest in an index fund ETF or the exact same unlisted index fund.

ETF vs Index Fund Comparison

Feature	ETF	Index Fund
Structure	Traded on ASX like shares	Can be ETF or managed fund
Pricing	Real-time	Once daily (if unlisted)
Strategy	Passive or active	Usually passive
Access	Through brokerage	Through manager or platform

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Video: Index Funds vs ETFs

5:48

0:00
Don't invest in an ETF until you've watched this video.

0:02
Hi, I'm Kylie and part of my job is to write about index funds and ETFs. One of the most common questions I get is what is an index fund and how is it different to an ETF? And I get why it can be confusing. These two terms get thrown around like they're the same thing. But here's the twist. Sometimes they're the same thing and sometimes they're completely different.

0:22
So, I'm going to break that down and I'm also going to show you step by step how you can tell the difference and where you actually find that information before you invest.

0:35 Index Funds
Okay, so let's start with index funds. At its core, an index fund is a type of investment fund that aims to track a specific market index like the ASX 200 or the S&P 500. And you might ask, "Okay, what is an index?"

0:51 What is an Index?
Really simply, an index is a list of stocks, typically major stocks, that represent an entire market. So the ASX 200 is just a list of Australia's biggest 200 stocks. And the S&P 500 is a list of the 500 biggest public companies in the US.

1:07
So an index fund buys most of or all of the stocks in whatever index it's tracking. And if that index goes up, well, your investment follows. But here's the thing. An index fund describes the strategy, but not the structure. So you can invest in an index fund in a couple of ways.

1:24
You can invest using an unlisted managed fund and that includes things like your superannuation or a regular managed investment fund. Or you can invest in an index fund through an ETF, an exchange traded fund.

1:36
These are just investment funds that you can buy and sell on the stock market just like shares. So in Australia, at least when someone says index fund, they might be talking about a traditional fund or they might be talking about an ETF that tracks an index. Okay. So now to ETFs.

1:52 What are ETFs?
ETFs are a structure, a type of investment product, not a strategy. And of these very loosely, you have passive ETFs, which are index funds, and active ETFs, which is where a fund manager is picking stocks to try and beat the market.

2:07
So, for example, you might have an S&P 500 index fund, which is simply passively tracking the market. In this case, the S&P 500. Index fund managers have the easiest job in the world, which is why the fees to invest in an index fund are so low.

2:20
Then you have active funds that are trying to beat the S&P 500. They're trying to beat the market.
So, fund managers in this case believe that by actively buying and selling stocks and other types of assets, they can deliver higher returns than the market can, and they'll usually charge higher fees for their service.

2:36
So yes, all index ETFs are ETFs, but not all ETFs are index funds. And in fact, these days, ETFs can invest in just about anything, and they have all sorts of different structures and strategies.

2:48
So you've got ETFs that now hold stocks, property, cryptocurrency, gold, you name it. Some ETFs now are also very complex. Some short the market, so they deliver returns when the market is falling. Others use leverage to inflate their returns and by extension also inflating losses.

3:06
And there are also a lot of thematic ETFs. So you can see the best performing ETF in Australia over the last 12 months was the Beta Shares video games and e-sport ETF. It returned 57.63%. That is an ETF that invests in video game and e-sports stocks which is pretty wild. Pretty wild. Slow down.

3:27 How to tell if an ETF is an index fund?
Okay then. So, how do you know if the ETF you want to invest in is actually an index fund? This is a really good question and a super important one. So, I'm going to share a couple of ways you'll be able to tell the difference.

3:38
So, firstly, look at the name of the ETF. ETF providers are required by ASET to label their ETFs when they're actively managed or when they are more advanced or use riskier products like leverage or derivatives.

3:52
For example, actively managed ETFs use the word active in their name. ETFs that use leverage or short the market or use complex derivatives must use the word complex. If the ETF doesn't have either of these labels in their name and it includes the word ETF in the name, it's probably a passive index fund. And that's where the second check comes in.

4:12
Before you invest, you need to check the ETF provider page. You need to read the PDS, its product disclosure statement, as well as its target market determination, it's TMD. So, let me show you how it's done.

4:23
So I'm looking here at the Betashares Financial Sector ETF and I want to check whether that is a passive index fund. In this case presumably tracking financial sector stocks within an index. So I'm going to go to the page and I'm going to search for the target market determination.

4:41
Here it is. And I'm also going to look for the PDS, the product disclosure statement. All ETF providers must include both of these with every ETF that they offer. So the product disclosure statement will tell you what type of strategy the fund manager is using whether it is passive or actively managed and it will go into much more detail as well.

5:02
For instance, we can see that this ETF is passively managed and it tracks the performance of the index. The target market determination on the other hand will tell you whether or not the ETF is suitable for you and it will tell you in the target market summary.

5:17
So in this case, it tells me that it's suitable for a consumer with a medium to long investment time frame of 5 years and it is very high risk. Okay, so that's the difference between an ETF and an index fund. I hope that made sense. I know it can get quite complicated.

5:32
If you want more information, be sure to check out our best ETF page and our index fund guide. I'll leave links in the description below.

Did you know?

What are passive and active strategies?

A passive investing strategy is where a fund simply tracks an index, with little to no involvement from fund managers. For example an S&P 500 index fund will mirror the movements of the S&P 500.

An active strategy is where fund managers actively buy and sell assets in an attempt to beat an index (called beating the market). Many funds now use a combination of both passive and active strategies by tracking an index but with some active buying and selling by the fund managers where needed.

How do you invest in ETFs and index funds?

ETFs are easier to access if you have a small investment amount as you can start with as little as $500 on platforms like CMC Markets or Tiger Brokers.

Some specialist platforms, like CommSec Pocket or Raiz Invest, now even let you invest from as little as $50 or less, though you’ll only get a small number of ETFs to choose from.

Best ETF trading platforms in Australia

Traditional (unlisted) index funds often require a minimum of $5,000 or more and must be purchased directly through the fund manager.

What are fees to access ETFs and index funds?

There are three main fees you need to worry about when you're investing in ETFs and managed funds, including index funds – management fees, trade fees and performance fees.

Management fees

Both ETFs and unlisted index funds charge a management fee which is a percentage of your overall portfolio. This fee is typically between 0.05% and 2.50%.

ETF management fees are often cheaper than unlisted managed funds, but this usually depends on the overall strategy of the fund. Passive index funds typically have the lowest management fees, while actively managed funds or more complex funds will charge a higher fee.

The cheapest ETFs on the ASX

Trade fees (brokerage)

These are the fees you pay whenever you're transferring money into (or out of) your investment fund.

If you're investing in an ETF, you'll need to pay a brokerage fee to whatever platform you're using to access that ETF. Brokerage fees range enormously, typically between $3 - $30, depending on the platform you use. It's worth noting that some platforms offer $0 brokerage deals for ETFs but charge a sell fee or a monthly account fee.

If you're investing in an unlisted index fund, you wont need to pay a brokerage fee, however your initial investment might need to be higher than with an ETF and you may also need to pay a higher management fee.

Performance fees

Some investment funds, including ETFs and some more complex index funds, charge a performance fee in addition to the management fee.

This fee is usually charged as a small percentage of any returns your fund makes above and beyond its goal of beating the market. It's worth checking whether your investment fund charges this (check the PDS) because this fee can eat into your returns, even if the fund appears to be performing well.

How do ETFs and Index funds perform?

How index funds perform will depend on how the index they're tracking performs.

For example, the Betashares NASDAQ 100 ETF (NDQ), which tracks an index of the top 100 companies on the Nasdaq, has returned 16.51% per year on average over the last 5 years, closely mimicking the Nasdaq-100 index – though it will never be exactly the same.

However ETFs can follow many different investment strategies and not all are passive index funds like NDQ.

For example, some ETFs track the bond market, which is very low risk, but also offers very low returns, typically less than 5% p.a. Other ETFs track commodities, like gold or oil, which may perform very well in some years, but poorly in others.

Some of the worst performing ETFs can be quite complex (and risky), using leverage (borrowed funds) to maximise returns (and losses).

For this reason, make sure to check the investment strategy and pair it with your risk profile before investing.

Tax implications of ETF and index funds

ETFs can be more tax-efficient than traditional unlisted index funds because of how they're structured and how trades are handled internally within the fund.

Traditional index funds often need to sell assets to raise cash when investors redeem their units. This can trigger a capital gains tax event inside the fund, which is then passed on to all investors as a taxable distribution, even if you didn't sell anything yourself.

ETFs, however, use a process called "in-kind redemption." When investors want to redeem ETF shares, the fund can hand over the underlying stocks directly, without selling them. This reduces the need to sell on the open market, which in turn helps minimise taxable capital gains for all ETF holders.

Both product types can pay dividends and may be eligible for franking credits. Both are also subject to CGT if sold for a profit, though you're awarded a 50% discount if you stay invested for 12 months or more.

Did you know?

Tip: Consider using DRPs (dividend reinvestment plans) to compound returns
With ETFs, you'll need to check whether DRP is available through the ETF provider. You'll usually need to apply yourself through the ETF's share registry.
With unlisted index funds, the fund manager applies the DRP directly and reinvests dividends into the fund on your behalf.

How comparing saved Alex $260 in fees

Alex had $10,000 to invest. He compared VAS (ETF) and Vanguard's unlisted index fund version. Over one year:

ETF: $5 brokerage + 0.07% management fee = $12
Unlisted index fund: no brokerage + 0.16% fee = $16

Alex plans to invest once a year for at least the next five years, though he'd like the option to invest more often if he can.

In the end, Alex chose the ETF because even though he had to pay a brokerage fee, he liked the flexibility of being able to add small amounts whenever he liked. And because the management fee was higher with the unlisted index fund, this largely offset what he would pay in brokerage fees with the ETF.

Choosing the ETF potentially saved him in fees and gave him ultimate flexibility to buy and sell when he chose.

What's best for you?

Winner for beginners or frequent investors: ETF
Winner for high net worth or autopilot portfolios: Index fund
Overall verdict: ETFs suit most Aussie investors because of ease of access and flexibility, but unlisted index funds are better for pure long-term buy-and-hold with minimal interaction.

Frequently asked questions

Some ETFs actually are index funds, so it depends how you look at it. If you're thinking of an index fund as your traditional unlisted investment fund, then both can be advantageous depending on how you use them. The benefit of choosing an ETF is you can invest smaller amounts more frequently and easily through a trading app. With an unlisted index fund, you often need $5,000 or more as a minimum investment and will need to go through an application process to add more funds or withdraw.

Sources

Thank you for your feedback!

Written by

Kylie Purcell

Investments Analyst

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Kylie Purcell is an experienced investments analyst and finance journalist with over a decade of expertise in a wide range of financial products, including online trading platforms, robo-advisors, stocks, ETFs and cryptocurrencies. She is a sought-after commentator and regularly shares her insights on the AFR, Yahoo Finance, The Motley Fool, SBS and News.com.au. Kylie hosts the Investment Finder video series and actively contributes to the investment community as a judge and panellist. She holds a Master of Arts in International Journalism, a Graduate Diploma in Economics, and ASIC-recognised certifications in securities and managed investments. See full bio

Kylie's expertise

Kylie has written 167 Finder guides across topics including:

Investment strategies
Financial platforms
Stockbrokers
Robo advisors
Exchange traded funds (ETFs)
Ethical investing
ASX stocks
Stock and forex markets

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ETFs vs index funds: What’s the difference?

An ETF might be an index fund or it can follow a completely different investment strategy.