As “passive management” (or rather, management with passive instruments ) grows, the investor may wonder what is better to use Index Funds or ETFs ( Listed Index Funds).
Both types, as their name indicates, share the concept of indexing, that is, the replica of an index. Therefore, they are two faces of the so-called “passive management” or two vehicles with similar characteristics, but with some relevant differences that we are going to discuss.
Before we remember the main characteristics of each of them:
What is an index fund?
An index fund has the same legal and formal structure as a traditional investment fund, but unlike the latter it does not “actively manage or select” the shares that compose it, but simply buys “passively” and constantly all components of the index. Being an investment fund it has a unique net asset value at the end of the day.
What is a listed index fund or ETF?
A listed index fund or ETF, like an index fund, replicates (in most cases) an index. But, instead of having a net asset value at the end of the day, when listing on the stock exchange, it has a net asset value that is constantly updated while the market where it is listed is operational. In this sense, we can affirm that an ETF is a hybrid between an investment fund and a share.
Let’s see in the following comparative table the main differences between one and the other:
Which is better an index fund or an ETF?
As we see in the column “Best asset” there is no product for which everything is advantageous. Therefore, the choice of one asset or another will depend on the type of portfolio that we want to build.
Clearly ETFs are better off in aspects such as accessibility, commissions and offer giving more game to make strategies beyond “pure passive management”. That is why it is the asset that is being imposed worldwide.
But in ETFs are still a minority asset for several reasons:
The index fund, for the professional, can have zero subscription and redemption costs, while in an ETF it will always have sale and purchase costs.
But in reality, where the indexed fund in Spain clearly stands out is in the simplification of the tax treatment that the deferral regime entails. This causes some private investors to even tend to go for the fund. In addition, it greatly simplifies annual tax reporting. While we do not sell we will not be reporting anything to the estate. This is only valid for Spanish private investors.
While the impasse in the application of transferability in ETFs is not clarified, techniques can be applied to optimize taxation. We apply intelligent tax optimization techniques that help achieve similar effects to tax deferral by generating tax credits that can then be offset with profits. Both assets, both Index Funds and ETFs, have advantages in implementing a diversified and efficient portfolio.