When it comes to financial investing, especially for beginners, I like to recommend investing in ETFs and index tracker funds, as opposed to mutual funds, due to the lower cost and (on average) better performance. In this post, I would like to discuss with you the difference between index tracker funds and ETFs. While these two financial products function in a very similar way, there are also some clear differences to be aware of.

ETFs (Exchange Traded Funds) vs. Index Tracker Funds

Both ETFs and index trackers aim to replicate an underlying index, such as the S&P500 Stock Index, so that investors can passively invest in the asset class they choose at a low cost.

Firstly, a big difference between index tracker funds (such as the Vanguard 500 Index Fund for example) is issued by the fund management company. That means you buy your holding directly from the fund management company at a price that is determined once a day. When purchasing an ETF, on the other hand, you are buying your holding on the stock exchange (as all ETFs are traded on stock exchanges). That means you can buy and sell ETF holdings throughout the day like you would when trading stocks.

Secondly, due to the rise in popularity amongst ETFs there is now a wide range over possible ETFs to invest in (over 1,400!). Whereas index tracker funds, on the other hand, are rather limited. That means using ETFs you can invest in a much broader range of markets (such as China, Vietnam or the Philipines for example).

Thirdly, even though fees for both ETFs and index tracker funds are very low, compared to actively managed mutual funds, ETFs tend to come at a slightly lower cost than index trackers. This is due to the increased competition in the ETF space as the asset class grows.

Fourthly, index trackers tend generally reinvest your dividend payments for you back into the fund. Whereas ETFs tend to pay dividend and coupon payments out in cash, for you to reinvest as you wish.

So, which one is the better investment product?

Unfortunately, there is no clear answer to that. The answer is ‘it depends’. It depends on the fees that your online broker charges you to purchase ETFs compared to index funds. It depends on what kind of exposure you are looking for (are the markets you want to invest in covered by index trackers or not?). It depends on how liquid or illiquid the ETF is you would like to buy (as illiquid ETFs will have a higher bid/offer spread, meaning that you will pay more to purchase the ETF). It depends on the fee structures of the specific index trackers or ETFs you want to invest in.

The key to choosing whether to invest in an index tracker or an ETF, for the specific market you want exposure to, is to compare the available options and take into account the above-mentioned factors. Then, whichever offers the lower-cost alternative, should be the one you go for.