Both index funds and exchange-traded funds (ETFs) have strengths, limitations, and best-use techniques. Although they are comparable in many respects, ETFs trade more like stocks and may have lower expense ratios.
If you’re looking for the UK best index funds or ETFs to invest in, continue reading to find out more about the differences between these products and which one could be best for you.
The Differences between ETFs and Index Funds
How they are bought and sold
The most significant distinction between ETFs and index funds is that ETFs may be exchanged like stocks throughout the day, but index funds can only be purchased and sold at the conclusion of the trading day.
This isn’t a major worry for long-term investors. Buying or selling around noon or 4 p.m. is unlikely to have a significant influence on the investment’s value in 20 years. ETFs, on the other hand, are a better option if you want to trade intraday. Despite the fact that they may be traded like stocks, investors can still profit from diversification.
Minimum investment requirements
ETFs often have lower minimum investment requirements than index funds. Most ETFs only need the amount required to purchase a single share, and some brokers, such as Robinhood, even provide fractional shares.
However, when it comes to index funds, brokers sometimes impose minimums that are far greater than the average share price. Vanguard, for example, requires a $3,000 minimum first investment for most of its index funds, while T. Rowe Price requires a $2,500 minimum beginning investment.
Cost of ownership
From an expense ratio standpoint, both ETFs and index funds may be quite inexpensive to purchase.
Trading commissions are another expense to consider. If your broker charges a commission for trades, you’ll be charged a fixed cost every time you buy or sell an ETF, which might cut into your profits if you’re a frequent trader. However, some index funds have transaction fees when you purchase or sell them, so compare expenses before deciding.
Capital gains taxes paid
Due to the way ETFs are designed, they are naturally more tax efficient than index funds. When you sell an ETF, you’re usually selling it to another investor who is interested in buying it, and the money comes from them. You are solely responsible for paying capital gains taxes on the transaction.
You must technically redeem cash from an index fund from the fund management, who will then have to put securities up for sale to create the funds to pay you. When a sale results in a profit, the net gains are distributed to all investors who own shares in the fund, which means you might owe capital gains taxes even if you never sell a single share.
Finally, as compared to most actively managed mutual funds, index funds and ETFs are also low-cost choices. To choose between ETFs and index funds, evaluate each fund’s expense ratio first, because this is a continuous fee you’ll pay for the duration of your investment. It’s also a good idea to look into the commissions you’ll have to pay to purchase or sell the investment, though these costs are generally minor unless you buy and sell frequently.
