By Soham Aher. Edited by Aniket Bose and Swastik Patel.
Introduction
An ETF is made up of a portfolio of diversified investments, such as stocks, commodities, bonds, and other securities. We refer to these assets as holdings. A type of mutual fund known as an “index fund” aims to mimic the performance of a market index. A few market indices that index funds could try to follow are the Wilshire 5000 Total Market Index, Russell 2000 Index, and S&P 500 Index.
ETFs
A pooled investment product called an exchange-traded fund (ETF) functions similarly to a mutual fund. ETFs mainly follow a certain sector, index, commodity, or other forms of assets; Unlike mutual funds, they may be bought or sold in the stock market just like conventional stocks. Anything from the price of a single commodity to a sizable and varied group of assets can be tracked by an ETF. They may even be designed to follow certain investing strategies.
When the stock markets are open throughout the day, an ETF may be purchased and traded much like a stock of a corporation. An ETF has a ticker symbol, much like a stock, and intraday price data may be easily accessed throughout the trading day. For example, Netflix has the ticker symbol “NFLX” on the NASDAQ Stock Exchange.
Due to the ongoing issuance of new shares and the redemption of existing shares, ETFs’ share count can fluctuate daily, unlike corporate stocks. The market price of ETFs are maintained in line with the value of their underlying assets by the capacity of an ETF to continuously issue and redeem shares.
| Advantages of ETFs | Disadvantages of ETFs |
| Easy to trade – You can buy and sell at any time of the day. | Tracking error – While ETFs generally track their underlying index fairly well, technical issues can create discrepancies. |
| Transparency – Most ETFs are required to publish their holdings daily. | Settlement dates – ETF sales are not settled for 2 days following a transaction. |
| More tax efficient – ETFs typically generate a lower level of capital gain distributions relative to actively managed mutual funds. | Illiquidity – Some thinly traded ETFs have wide bid/ask spreads. |
Index Funds
A mutual fund or exchange-traded fund (ETF) known as an index fund has a portfolio built to replicate or follow the components of a financial market index, such as the Standard & Poor’s 500 Index (S&P 500). A mutual fund that invests in an index is considered to offer low operating costs, wide market exposure, and minimal portfolio turnover. Regardless of how the markets are doing, these funds continue to invest in their benchmark index.
Since the fund is just mimicking a certain index, index investors don’t need to actively monitor their stocks and bonds investments as closely. This is what distinguishes index funds from mutual funds and is the reason why they are often referred to as passive investments.
The assets in mutual funds are actively handled by fund managers. With mutual funds, the objective is to outperform the market, but with index funds, the objective is to merely mirror the performance of the market. Since daily human administration is not necessary for index funds, they have lower management expenses (also known as “expense ratios”) compared to mutual funds.
| Advantages of Index Funds | Disadvantages of Index Funds |
| Lower risk through diversification | Vulnerability to market swings and crashes |
| Ideal for passive, buy-and-hold investors | Lack of flexibility |
| Lower taxes for investors | Limited gains |
Conclusion
In conclusion, index funds are a collection of securities that mimic an index of the performance of the financial markets. When you purchase an ETF, you receive a collection of assets that you may buy and sell during trading hours, possibly reducing your risk and exposure and assisting with portfolio diversification.
