Index Funds vs. ETFs: How Each Can Help You Build Wealth

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If you’re a beginner investor, index funds are for you

Index funds are baskets of stocks that track a portion of the stock market — or in some cases, the entire market. For example, you can invest in an index fund that tracks the S&P 500, which are the 500 biggest companies in the U.S. So when you buy index funds, you buy a piece of the whole stock market. When the market is up, your portfolio is up, and vice versa. 

There are two ways to invest in index funds — mutual funds and ETFs. The two are very similar: both are baskets of stocks. There’s one major difference in terms of how they trade. But the differences are so slight, it doesn’t really matter which one you choose.

“We’re literally splitting hairs because they’re so close,” says Delyanne Barros, an investing expert and money coach. “New investors tend to overly focus on this but it’s one of those things that leads to overwhelm. It’s not something worth spending too much time stressing about. Just pick one and stick with it and move on.”

Pro Tip

Even though ETFs and index funds are great investments for beginners, do your research before making a commitment with your investing portfolio. 

Whichever way you decide to invest, index mutual fund or index ETF, the best thing you can do is get started early and keep investing. 

Here’s what you need to know about ETFs and index funds. 

What Is an Index Fund?

Experts love index funds, and for good reason. They are reliable and cost-effective ways to build long-term wealth, and they’re suitable for everyone. 

An index fund is a group of assets, such as stocks or bonds, that is designed to track the performance of a specific financial market. 

There’s an index fund for nearly everything, but the ones recommended by financial experts for building wealth are those that track very large groups of stocks. For example, an index fund that tracks the S&P 500 lets you invest in each of the largest 500 companies in the U.S. Together, these companies make up about 80% of the entire stock market, so an S&P 500 index fund is a cheap and easy way to diversify your portfolio. 

Index funds are low-cost, with fees as low as zero, and available to all investors. You can invest in an index fund through a taxable brokerage account or a tax-advantaged retirement account like a 401(k) or Roth IRA. Index funds help diversify your portfolio, and their proven track record shows they’re more stable investments when compared to other types of alternative assets like crypto.

What Is an ETF?

Not every index fund is the same. Some are mutual funds, while others are ETFs, which stands for exchange-traded funds. The differences are small and, for long-term investors, not very significant. 

An ETF is a type of index fund. Like any index fund, an index ETF provides instant diversification in your portfolio, which will help keep it safe from downturns in the market, at a low cost.

However, ETFs are bought and sold differently than mutual funds. Unlike a mutual fund, which sets its trading price at the close of the market each day, an ETF can be bought and sold during the day like a stock. 

“The price of your ETF will depend on what time [of day] you buy it,”  says Barros.

ETFs may have lower fees when compared to comparable mutual funds, though not always. 

Which Is Right For You?

Remember that index funds, whether they are ETFs or mutual funds, bundle together lots of individual investments, which helps keep your portfolio diversified and low-risk.

They’re also low-cost. The biggest index funds are passively managed—meaning they are automatically selected to match a certain part of the stock market—which keeps fees or expense ratios low. 

Some index funds are ETFs, which means they are traded differently than traditional mutual funds. ETFs trade like stocks. You can buy and sell shares of ETFs on the stock exchange throughout the day, whereas mutual funds trade once a day. 

Whether you buy an index as a mutual fund or ETF, you’ll still get all the same benefits. “I don’t want anybody to panic. Whichever one you pick, you’re totally fine,” says Barros.