How can you compare ETFs and index funds?

ETF: [1] ETFs are traded on stock exchange like stocks. [2] Have a low expense ratio, relatively liquid and actively managed. Index Funds: [1] These are traded only once at the end of trading day. [2] They track a specific index and are passively managed.

For investors who want to access market performance i.e. “beta”, passive ETFs can be an invaluable tool to aid asset allocators and investors alike in building a balanced portfolio. There are many important considerations when reviewing different passive ETF providers including the method of reproduction, total expense ratio, hedge or unhedged currency, leverage, accumulation or distributing units, benchmark, and tracking error to name but a few. Despite being an active fund manager myself, there is a fantastic book called ‘A Random Walk Down Wall Street’, by Burton G. Malkiel, which I would encourage any one with an interest in financial markets to read.

ETFs are ideal if you are looking to trade frequently or if you want exposure to niche themes for which there is no index. Else, for the vast majority of investors, low-cost index funds are the best option as recommended by Warren Buffett himself.

That's a solid breakdown! ETFs and index funds offer different ways to invest, with ETFs being tradable on exchanges like stocks and index funds aiming to match the performance of specific indices. The flexibility in their structures caters to different investment preferences.

ETFs can be very handy when getting into more volatile asset classes like gold or silver and even tactical sectors like lithium as they are easy to trade. Index funds are more for passive investors who want to replicate the performance of a particular index like the S&P500 without much headache.

In general, ETFs have lower cost than index funds. But one also needs to consider the liquidity in an ETF (i.e. how many units are traded each day) as that can impact the bid-ask spread. This means that you could receive a lower than expected price when you sell your ETF units and have to pay a higher than expected price when you buy ETF units. Sometimes this can be as high as 1%, if not more. So the advantage of lower cost can get offset by the higher bid-ask spread due to low liquidity. This is especially the case for niche thematic ETFs and is less applicable for index ETFs.

Possibly, costs and taxes will depend on the country of residence of the person using these investment vehicles. In Spain, for example, the taxation of investment funds (including index funds) allows transfers between funds (individuals resident in Spain), taking advantage of tax deferral (no taxation until the units are sold). However, this tax-deferred transfer mechanism cannot be used with ETFs.

Absolutely, you've highlighted key distinctions between ETFs and index funds. ETFs tend to have lower fees, including expense ratios, and their structure often leads to greater tax efficiency compared to index funds, particularly mutual funds, due to their ability to minimize capital gains distributions. This can impact an investor's returns over time.

As explained earlier, while liquidity in index ETFs is quite high, it can be low in case of niche thematic ETFs and that can impact the price which is a negative for investors. However, whereas index funds provide broad-based exposure and are limited in number, ETF providers can create ETFs for any niche themes or segment. So an investor has more options for long-term diversification, they can take medium-term calls on themes, and they can also take short-term trading positions using ETFs.

You've covered two more significant differences between ETFs and index funds: liquidity and diversification. ETFs tend to offer higher liquidity due to their continuous trading on exchanges, while index funds, especially mutual funds, trade less frequently and have a net asset value determined at the end of the day. Moreover, ETFs can often provide more diversified options, including exposure to specialized sectors or themes, compared to some index funds.

Liquidity is important in any security or asset being traded. ETFs will generally have more liquidity depending on various factors like the size of exchange, provided resources, investor interest and performance while Index Funds have a tendency to have less liquidity traded directly on the exchange, with spreads that can vary for investors as they trade only once a day. Speculating with spread is a criteria that must be recognised by any investor.

Absolutely, technical analysis provides tools and indicators to compare ETFs and index funds based on their historical price movements, volumes, trends, support/resistance levels, volatility, and momentum. Analyzing these aspects aids in evaluating relative performance, risk, and opportunities, assisting traders and investors in aligning their preferences, objectives, and risk tolerance with the chosen funds. It's a methodical approach to make informed investment decisions.

Since ETFs trade throughout the day, just like a stock, technical analysis on ETFs is easier and makes more sense. So, one can look into using Technical Analysis as an input for trading using ETFs. Index Fundsare just like a Mutual Fund and disclose their NAV just once a day after market close. So the granularity of data is lot less as compared to ETFs. Hence, it's better to use index funds more for medium-to-long term investment than for trading.

You can use technical analysis indicators and tools provided by exchanges and investment platforms to analyse candlestick charts, compare volume, order book data and view historical performance of each fund type, allowing the investor to properly align with their risk, goals and style. This is only scratching the surface with technical analysis, as there are many tools and services being created to help investors make higher probability speculations.

In India, only a few ETFs like the Nifty ETF, Nifty Next 50 ETF and Bank Nifty ETF have good liquidity. Although there are many other ETFs in the market, liquidity is quite low and bid-ask spread is quite high. It will take some time for awareness regarding ETFs to increase and for liquidity to rise. For the vast majority of investors in India, low cost index funds may still be the best option to consider for medium-to-long term investment as recommended by Warren Buffett.

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Whenever looking at assets from a technical perspective it is also good practise to consider fundamental data in your analysis to help you with decision making. As we humans naturally have a tendency to tie emotions to decisions, investing requires a lot of training, patience, education persistence and finally discipline. Combining findings of data with fundamental news can help assist in making a great speculative decision on whether a Index Fund or ETF is right for you.