With my last post, I mentioned that index funds are good for small capital investors like me. I recently read up about Exchange Traded Funds (ETF) which are similar to index funds in that they also track an index and do not look to out-perform the market.
So which is better for my money? Index funds or ETFs? I'll use this post to try to analyze their pros and cons.
Firstly, the similarities - Both are indices. This means that they are a collation of equities that track a specific index. The index can be anything, ranging from the Dow Jones, to Foreign Stock Exchanges or even commodities or currency. So joining either one will result in diversification of your investments. Which is a good thing, considering that I don't have the knowledge nor the time to research extensively into specfic stock at the moment.
Now the differences.
The ETF is treated like a STOCK. This means that a ETF
- can be bought and sold on the stock exchange
- are priced in real-time. It can vary by the hour.
- are purchasing by a broker. This entails that you pay a brokerage commission in your purchase.
- pays out dividend quarterly. Any dividend pay out from the indexed companies will be saved till then.
- has a small (typically ~0.1-0.2%) management commission to the company that maintains the ETF (tracking and composition of the fund).
- generally has a lower tax implication than an index fund (if it is bought and held) since rebalancing does not involve selling and buying of stock.
The index fund is a mutual fund. This means that
- the price of the fund is determined by it's Net Asset Value (NAV), which is valuated at the end of the day. This means that if you sell/buy a fund today, you won't know the exact price till 1-2 days in the future due to calculations of NAVs. - it will generally have a higher (but still small) management commission (typically <1%).
- there are NO brokerage commissions.
- any dividends paid by indexed companies will be reinvested or paid out without being withheld till the end of the quarter.
- typically will have a higher tax impact (if bought and held) since funds will rebalance by buying and selling stocks (hence invoking capital gains).
For the long-run, small capital investor (i.e. ME), I think the most important difference is the cost of owning or making a transaction with the ETF or index fund. I am not interested in day trading nor do i have a lot of money up-front to invest. I would rather purchase something and watch it grow over months and years. If there is dividend, that would just compliment my income.
ETF's have a lower maintenance fee than an index fund. However, it incurs a cost PER purchase. Typically, this cost ranges from USD7 to USD15 per transaction depending on the brokerage used. So ETF's would appeal to someone who makes a one-time big purchase.
Index funds, on the other hand, have a higher (but still quite low) maintenance fee . However, there is usually NO cost per purchase (for no-load funds). This means that if you plan to invest gradually, like a small investment per quarter, it might be cheaper to do an index fund.
It really comes down to how much does the transaction cost of the ETF compare to the extra maintenance fee of the index fund. I will search out comparable ETF's and index funds to analyze in a later post.
So which is better for my money? Index funds or ETFs? I'll use this post to try to analyze their pros and cons.
Firstly, the similarities - Both are indices. This means that they are a collation of equities that track a specific index. The index can be anything, ranging from the Dow Jones, to Foreign Stock Exchanges or even commodities or currency. So joining either one will result in diversification of your investments. Which is a good thing, considering that I don't have the knowledge nor the time to research extensively into specfic stock at the moment.
Now the differences.
The ETF is treated like a STOCK. This means that a ETF
- can be bought and sold on the stock exchange
- are priced in real-time. It can vary by the hour.
- are purchasing by a broker. This entails that you pay a brokerage commission in your purchase.
- pays out dividend quarterly. Any dividend pay out from the indexed companies will be saved till then.
- has a small (typically ~0.1-0.2%) management commission to the company that maintains the ETF (tracking and composition of the fund).
- generally has a lower tax implication than an index fund (if it is bought and held) since rebalancing does not involve selling and buying of stock.
The index fund is a mutual fund. This means that
- the price of the fund is determined by it's Net Asset Value (NAV), which is valuated at the end of the day. This means that if you sell/buy a fund today, you won't know the exact price till 1-2 days in the future due to calculations of NAVs. - it will generally have a higher (but still small) management commission (typically <1%).
- there are NO brokerage commissions.
- any dividends paid by indexed companies will be reinvested or paid out without being withheld till the end of the quarter.
- typically will have a higher tax impact (if bought and held) since funds will rebalance by buying and selling stocks (hence invoking capital gains).
For the long-run, small capital investor (i.e. ME), I think the most important difference is the cost of owning or making a transaction with the ETF or index fund. I am not interested in day trading nor do i have a lot of money up-front to invest. I would rather purchase something and watch it grow over months and years. If there is dividend, that would just compliment my income.
ETF's have a lower maintenance fee than an index fund. However, it incurs a cost PER purchase. Typically, this cost ranges from USD7 to USD15 per transaction depending on the brokerage used. So ETF's would appeal to someone who makes a one-time big purchase.
Index funds, on the other hand, have a higher (but still quite low) maintenance fee . However, there is usually NO cost per purchase (for no-load funds). This means that if you plan to invest gradually, like a small investment per quarter, it might be cheaper to do an index fund.
It really comes down to how much does the transaction cost of the ETF compare to the extra maintenance fee of the index fund. I will search out comparable ETF's and index funds to analyze in a later post.
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