Investors can be confused as financial advisers and other market participants often use ETF and Index Funds interchangeably. Are there differences between exchange traded funds and index funds? and if so which is better ETF vs Index Fund? and most commonly how to invest in index fund?
What is an ETF?
Exchange Traded Fund is the product that tracks a particular set of asset classes such as Equities, Bonds and Commodities. These funds are listed on the Australia Stock Exchange and are open ended. An open ended fund means that investors can add investment in the fund through purchase of units at anytime when markets are trading. There is no commitment minimum commitment period for the investment.
What is an Index Fund? (Not Indexed Fund)
Index funds are a subset ETF products. It is not called indexed fund but an index fund because the goal is to track the performance particular indicies rather than actively trying to pick winners and losers. Therefore index fund return is simply the return of the market.
For example the ASX 200 ETF track the performance of the ASX 200 Index. The investment mandate of the funds is to replicate the performance of the index which means the investments in the portfolio matches exactly what is in the indices.
The key difference is that only because it is a index fund does not mean it is listed on the stock exchange. All ETFs are listed.
How to Invest in Index Fund?
Major investment platforms will have low cost index options. If they don’t, then they are not even worth considering because all that is left is just high cost investment profits with fat commissions for the advisers.
Investing in index funds should be as easy as choosing the index fund option, usually the product description clearly state that they track the market only and do not pick stocks. Of those investment platforms which can purchase shares on the ASX.
Investors can buy Exchange Traded Products that track the market directly on the ASX.
Low Cost Index Fund
The low management cost can be considered the main advantage of investing in an index fund.
For the last 2 decades the passive investment industry has been eating active managers lunch. The asset management industry have been woefully in delivering market beating performance where the biggest secret in investment industry is a portfolio of index funds is the best option for a large portion of the population.
A typical index fund expense ratio are in the range of 0.20% to 0.40% a year. This is can be a fraction of active funds where typical 1%+ fees can be expected. Over the long run the difference compounds which can result in a large difference in the investment portfolio.
Different Index Tracking Funds
There could still be a twist to traditional index tracking fund in addition to just track the major indices like the ASX20.
For example here is a large variety of index funds investors can use from dividend index funds (or high yield funds like ASX VHY) which aim to purchase stocks which only meet a specific dividend yield threshold or history of paying dividends.
Separately, there are also sector specific funds which focuses on equities only in a single sector like resources, financials or real estate (AREIT).
There are also commodity ETFs which provide specific commodity exposure like copper, gold or silver.