As the world of investments becomes more well-known, more questions arise about some concepts specific to this area, such as the difference between index funds and ETFs . This means breaking down the characteristics of each of these products. In this way, you will be able to decide whether an ETF or an index fund is better.
It is important to be clear about these terms and know the advantages and disadvantages of each one, since as an investor, you will have to direct your capital to that which will give you the greatest profitability and knowing all the options that the market offers is an advantage.
Both index funds and ETFs belong to passive management , which is defined as a series of investment strategies where the fund manager has a secondary role, so the participation of the investor will be much more active. Contrary to what happens in active management.
Learn the differences between ETFs vs index funds.
How ETFs work
Before understanding how ETFs work, you must first understand what they are and what they are used for. They are exchange-traded funds, which are a hybrid between a traditional investment fund and a stock.
They are made up of a basket of securities and each share represents a portfolio of shares that seeks to replicate the performance of certain indices . They work in the same way as shares: they are listed throughout the trading session.
Its value is net asset value, which means that it is published at the end of each session. Another of its great features is that investors can purchase ETFs in real time, at the price that is currently set on the market.
This type of investment has the particularity that it is listed on the stock exchange, just like shares. In addition, its management is passive, since it aims to replicate a certain index.
Buying and selling can be done without having to close the market and know the net asset value, as is the case with investment funds. This is a great advantage for participants.
There is no minimum investment, meaning you can invest from the minimum price of a share. There are also no subscription or redemption fees, although you will pay fees when buying and selling, as is the case with a share.
How Index Funds Work
These funds are managed by a management company or entity , which is responsible for the purchase and sale of assets from which profits are sought, based on a certain risk.
Individuals who participate in this fund can subscribe to or redeem shares, depending on their value on the day of the transaction, more specifically, at the time the market closes.
In index funds, transactions are always carried out through a management company , unlike what happens in listed funds that execute their operations in secondary securities markets, as is the case with shares.
Within this type of investment, there are a number of advantages, such as the possibility of participating with minimum amounts, possible returns and different classes, as well as tax advantages for the transfer of funds.
On the other hand, index funds seek to replicate a certain reference index, as well as its rises and falls, and since there is no active management, the fees are much lower. Unlike what happens in traditional funds.
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Similarities between both
The only similarity between ETFs and index funds is that both are passively managed, in which the manager does not monitor all operations, so the fees are much lower.
On the other hand, both offer a simple way to diversify your portfolio, because they give exposure to hundreds or even thousands of securities, based on the index they accumulate.
This helps the portfolio to be negatively affected by constant market changes. This makes index funds and ETFs interesting products for the financial institutions that offer them.
Differences between ETFs and index funds
This is a key question in the investment world: what is the difference between a fund and an ETF?
ETFs and index funds are different and so that you have no doubts, I will explain them to you below:
Purchase and sale operations
In the case of ETFs, you have to pay for each purchase and sale transaction carried out, just like with shares. In addition, it will be immediate at the value quoted at that moment.
Index funds have a subscription and redemption fee (not applicable to all funds). On the other hand, the price will not be set at the closing price of that day.
Commissions
Another difference between index funds and ETFs is the fees, since in the latter case they are lower, but you pay for each operation you carry out. However, this does not happen with index funds.
Accessibility
You can hire any broker to monitor your movements and investments, because it is treated like a stock. Index funds limit access to certain entities.
An example of this is Vanguard Spain's index funds, in which only BNP Paribas can be included.
Taxation
Index funds are listed like investment funds and there is no transfer between funds. This is a great advantage, as they can be taxed in the long term. Therefore, it is in terms of taxation where index funds beat ETFs .
In contrast, ETFs work like stocks , so you have to pay taxes when you unwind a position. In addition, you have to pay taxes on each change of ETF.
Offer
ETFs have a broader offering than index funds, including sector ETFs that do not involve replication in index fund format.
Which is better, an index fund or an ETF?
To know which is better, whether an ETF or an index fund, you must review your long-term objectives, since an investment does not produce profits in a short period of time. You must also consider that once you enter into any of these products, you will have to assume some costs.
If you have experience trading stocks, then the ETF will be much more feasible for you. In addition, you will have to pay lower commissions, although the problem you may encounter is that you will have to pay taxes on all movements, since all brokers treat them as shares in the legal part.
This decision has yet to be made by the Ministry of Economy.
In short, index funds are more suitable for creating a passively managed portfolio, which will also serve as a savings fund for your retirement.
