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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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.
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.
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 17% 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
Dividend Reinvestment Plans (DRPs) let you automatically reinvest your dividends into more units of the fund instead of receiving cash.
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.
VAS is an ETF that passively tracks the ASX 300 index – so it's both an ETF and an index fund.
Yes. Like all investments, index funds can go down in value depending on market performance.
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.
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.
Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades. Read the Product Disclosure Statement (PDS) and Target Market Determination (TMD) for the product on the provider's website.
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 163 Finder guides across topics including:
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