One common way investors lower their risk is to diversify their holdings with different assets. When you hold a mix of investments, your portfolio is protected from being wiped out if one investment fails.
Exchange-traded funds (ETFs), mutual funds, and index funds are all assets that provide diversity as they pool investors’ money to purchase a basket of securities. By buying into a fund, you get exposure to a wide range of securities or other assets at once.
However, these three types of funds have different features that may make one option preferable for any one investor. Learn about the difference between ETFs, mutual funds, and index funds, including how they work, potential costs, and how to invest in them.
ETFs vs. Mutual Funds
An ETF is a fund with shares that are bought and sold over an exchange like the New York Stock Exchange (NYSE) or Nasdaq. They work similarly to stocks with share prices changing throughout the trading day according to market demand. An ETF may hold securities or assets like stocks, bonds, or money market instruments. You can invest in an ETF for the price of one share, which varies depending on the individual fund.1
A mutual fund also holds a basket of securities or assets, but you buy and sell shares through the mutual fund itself or through brokers, not over an exchange. Shares are priced each day, typically after major U.S. exchanges close, and you can only buy shares for this set price. Many mutual funds also have minimum investment requirements.2
Both ETFs and mutual funds are managed by professional investment advisors.
ETFs vs. Index Funds
ETFs and index funds both allow you to invest in a range of assets at once, which can be less expensive and less time-consuming than buying a variety of individual stocks and bonds.
An index fund is a type of fund that can be either a mutual fund or an ETF, and its holdings mirror a particular index. An index fund aims to provide the same return to investors as the market index it follows.
A market index typically aims to measure the performance of a bundle securities that represent a sector of the economy or a particular industry. For example, an index may follow the S&P 500, or the Nasdaq stock exchange, among many others. So, if you purchased a share of an index fund following the S&P 500, you would get exposure to hundreds of companies at once.3
Mutual Funds vs. Index Funds
Mutual funds and index funds are both assets that allow investors to invest in a wide range of securities at once.
An index fund may be a mutual fund, but it may also be an exchange-traded fund with shares trading on an exchange. Index funds track a particular index, investing in either all the securities in the index or only a sample.4
Investing in Funds
ETFs and mutual funds, including index funds, can benefit investors of all skill levels. You can invest in more aggressive funds that have more volatility, such as funds with growth companies. Or you can invest in lower-risk funds that hold assets that perform more predictably, like bonds.
- How to invest in ETFs: You can invest in an ETF by purchasing shares over an exchange like the New York Stock Exchange (NYSE) as you would buy stock.
- How to invest in mutual funds: To buy a mutual fund, you’ll purchase shares directly from the fund or through a broker, not over an exchange.
- How to invest in index funds: The way you invest in an index fund will depend on whether it is an ETF or a mutual fund. You can purchase shares of an exchange-traded index fund over an exchange, and shares of a mutual fund from the fund or through a broker.
The Bottom Line
ETFs, mutual funds, and index funds have many features in common, but which type of fund is right for you will depend on your investing preferences.
Like any investment, there is no guarantee that these funds will provide returns at all, and you could even lose money. Research several fund options and compare costs, including fees and commissions. And, before you buy into a fund, note the risks of investing this asset type as well as the unique risks of any specific fund you want to buy.
Have Questions About Investing?
Talk to a qualified financial advisor today to get professional advice. Need help finding a financial advisor in your area? Give us a call today so we can match you with an advisor who will put your needs first.
Investors cannot invest directly in indices. A diversified portfolio does not ensure a profit or protect against loss in a declining market.
1 Investor.gov, “Exchange Traded Fund (ETF) https://www.investor.gov/introduction-investing/investing-basics/glossary/exchange-traded-fund-etf
2 Investor.gov, “Mutual Funds and ETFs: A Guide for Investors https://www.investor.gov/sites/investorgov/files/2020-04/mutual-funds-ETFs_2_0.pdf
3 U.S. Securities and Exchange Commission, “Investor Bulletin: Index Funds” https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_indexfunds
4 Investor.gov, “Index Funds” https://www.investor.gov/introduction-investing/investing-basics/investment-products/mutual-funds-and-exchange-traded-4
