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What is the Difference Between an ETF and Index Funds?

A. Leverkuhn
A. Leverkuhn

ETFs and index funds are two separate but not mutually exclusive types of funds that present unique investment offers to those with available capital and a working brokerage service or account. Learning about the differences between fund types can help beginners make good decisions about setting up fund participation for a given time period. Investors should also be able to differentiate between different types of new financial products.

Exchange traded funds, or ETFs, are funds that have a specific setup. ETFs offer trading over big national exchanges. This implies certain requirements for disclosure, and also allows for intraday trading, making buys and sells easier for traders who want to get in and out of funds quickly. ETFs usually offer diversification between different kinds of single funds, stocks or products, which are collected into a “bundle” of equities that trade together.

Although most ETFs are passively managed index funds, in 2008 the U.S. Securities and Exchange Commission (SEC) approved the development of the first actively managed ETF.
Although most ETFs are passively managed index funds, in 2008 the U.S. Securities and Exchange Commission (SEC) approved the development of the first actively managed ETF.

Index funds are funds that are made to mirror the activity of a broader index. The index can be as broad as major stock indices like the Dow Jones, or S&P 500, or smaller indices of specific sector or market cap stocks. Index funds are by nature a more stable kind of fund that includes broader diversification and some desirable risk ratings for a portfolio.

ETF and index funds are not mutually exclusive products. Some ETF funds are index funds, and vice versa. ETF and index funds combine the appeal of broader equity bundling with the attraction of easy tracking and trading over a major stock exchange.

When looking at ETF and index funds, investors can dig deep into the fund report or prospectus to figure out what underlying equities actually support projected yields. They can also look at the track record of the company or individuals tasked with fund management. All of this is considered “due diligence” that will help investors make good plays on a sector or kind of stock.

Another important note about ETF and index funds is that these can be applied to much more than just stocks. Anything that can be traded and indexed is a potential source of ETF and index funds. These fund types may apply to “baskets” of commodities, international currencies, or any other financial products. That makes fund investing a major part of a variety of sophisticated trading strategies for individuals and institutions who want to widen their search beyond corporate shares on national exchanges.

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    • Although most ETFs are passively managed index funds, in 2008 the U.S. Securities and Exchange Commission (SEC) approved the development of the first actively managed ETF.
      By: leungchopan
      Although most ETFs are passively managed index funds, in 2008 the U.S. Securities and Exchange Commission (SEC) approved the development of the first actively managed ETF.