Mutual funds and exchange traded funds that follow an underlying benchmark index provide a passive way to gain broad market exposure. While the destination is the same, the investor should understand the differences between the two routes.
Index funds, like all other mutual funds, are bought and sold through the fund company, with shares priced once at the end of the trading day, writes Elliot Raphaelson for Chicago Tribune.
On the other hand, ETFs are traded through brokers on a secondary market. Consequently, the shares can be bought or sold throughout the trading day at up-to-date market prices, like any normal company stock.
ETFs also have no restrictions on the frequency of trades. Investors can use margins, sell short, utilize stop orders, implement limit orders or trade an open order, basically all the trading options associated with stocks. More aggressive traders who like to time their investments can now utilize ETFs to access broad and niche markets. [Don’t Confuse ETFs and Index Mutual Funds]
While the ETFs typically show lower expense ratios than mutual funds, investors also have to consider other direct trading costs. Since investors would have to trade ETFs on a brokerage account, broker fees will apply for every transaction.