One type of financial product receiving a lot of media attention in recent times is “ETFs”. But the benefits being espoused for ETFs sound very similar to the benefits of index funds. Is ETF just a new name for index funds?
Actually no. “ETF” is not a new name for index funds. But many ETFs are indeed a type of index fund. Index funds mimic the performance of a stockmarket index. They provide very similar returns to what you would achieve by investing in all the underlying stocks in the index. Their management cost is generally quite low.
By contrast “actively managed” funds attempt to provide higher returns than the index. But their management cost is also higher. Whether or not actively managed funds achieve sufficient additional returns to justify their higher management cost is a matter of some debate. And a topic for another day!
But back to ETFs. Or to give them their full name “Exchange Traded Funds”. As their full name implies, they are funds which are traded on a stock exchange. Historically, most funds, including index funds, have been bought or sold directly from the fund manager or via portfolio administration platforms. ETFs allow investors to buy and sell funds via the stock exchange instead.
The defining characteristic of ETFs is not their investment style, but their method of purchase and sale.
The reason the media often talks about ETFs as if they were the same as index funds, is because when ETFs were first introduced most of the early products were an index style. And these are still the most popular ETFs. However it is also possible for ETFs to be actively managed. Actively managed ETFs have proliferated in recent years. Not surprisingly, their fees are much higher.
If you are thinking of investing in ETFs based on the merits of index funds, be very careful that any ETF you choose is in fact a true index style. And be aware that ETFs are not the only way to access index funds. Index funds are also readily accessible via many super funds and portfolio administration platforms. For many investors this may be a simpler and safer option than trading ETFs via the stock exchange.