While both types of investments try to passively track an underlying benchmark index, index funds and exchange traded funds are different vehicles.
Investors may have heard the of the word “indexing” being thrown around in the fund industry to describe passive strategies, but there is a difference between ETFs and mutual funds that employ passive indexing.
For example, anyone with a brokerage account can buy or sell ETFs throughout the day. Meanwhile, index funds are only priced at the end of the trading day.
Beyond the fund structures, there are a couple of scenarios where trading an ETF is more favorable than using index-based mutual funds, writes Mitch Tuchman for Forbes. Specifically, Tuchman argues that ETFs are a good tool for do-it-yourself investors who want access to broad and alternative markets through a cheap investment vehicle.
Investment advisors who use index funds may have access to cheaper funds, avoid trading costs or negotiate down brokerage fees. The investor, though, would not have these connections. Instead, the average retail investor can execute trades on broad index-based ETFs at relatively low costs or even free on some brokerages that offer commission-free trades. [Six Popular Commission-Free ETF Trading Platforms]
While long-term investors should not day trade their holdings, investors do need to rebalance their portfolios every once in a while, and the trading fees to add up. Since most major broad-index ETFs can be traded commission-free on various brokerage platforms, it may make sense for the average investor to use these ETFs to help keep costs at a minimum.
Additionally, ETFs allow investors to access alternative assets to help diversify a portfolio. For instance, there are a number of passive, index-based ETFs that track real estate investment trusts, commodities and currencies to help provide exposure to assets that have low correlations to traditional stocks and bonds. [Alternative Asset ETFs Diversify Portfolios]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.