These three terms get used as if they were alternatives. They are not. One describes a strategy and the other two describe the container the investment comes in.
Index fund: a strategy
An index fund tries to match a market index, such as the S&P 500 or the S&P/TSX Composite, instead of picking winners. It holds the same companies as the index, in similar proportions. The manager does very little trading, which keeps costs low.
Mutual fund: a container
A mutual fund pools money from many investors. You buy and sell through the fund company at a price calculated once a day. Mutual funds can be index funds, or they can be actively managed, where a manager picks investments and tries to beat the market.
ETF: a container
An exchange-traded fund also pools money, but it trades on a stock exchange like a share, so the price moves throughout the day. Most ETFs track an index, but there are active ones too.
| Index fund | Mutual fund | ETF | |
|---|---|---|---|
| What it is | A strategy | A container | A container |
| How you buy | Either way | Through the fund company | On an exchange |
| Pricing | Depends on container | Once per day | All day |
| Typical fees | Low | Low to high | Often low |
Why fees matter so much
The yearly fee is called the management expense ratio, or MER. Broad index ETFs commonly charge well under 0.25%. Actively managed mutual funds in Canada often charge 1.5% to 2.5%, though it varies by fund.
Here is what the gap does. Invest $10,000 for 30 years with a 7% yearly return before fees.
- With a 0.2% fee, your net return is 6.8% and you end with about $71,968.
- With a 2% fee, your net return is 5% and you end with about $43,219.
That is a difference of roughly $28,700 from fees alone. The numbers are an illustration, and real returns vary, but the direction holds. See the effect of time in how compound interest works.
Does active management win?
Some managers beat the market in some years. Studies of fund performance regularly show that most active funds trail their index over long periods after fees, and it is hard to know in advance which ones will do better. That is the main argument for index investing.
All-in-one ETFs
Many Canadian providers offer all-in-one ETFs that hold stocks and bonds in a set mix and rebalance automatically. They suit people who want one simple holding. These are examples of a product type and not a recommendation.
Things to check before buying
- The MER and any trading costs. Commissions and account fees vary by brokerage.
- What index it tracks and where the companies are based.
- Which account to hold it in. A TFSA or RRSP can shelter the growth.
ETF vs index fund: the short answer
An index fund is a strategy: it copies a market index such as the S&P 500 instead of picking stocks. An ETF and a mutual fund are wrappers: they describe how you buy and sell the fund. So the real choice is usually between an index mutual fund and an index ETF that track the same index. The holdings and long-run returns are almost identical. What differs is how you trade them, the minimum to get started, and (in US taxable accounts) taxes.
Index mutual fund vs index ETF, side by side
| Index mutual fund | Index ETF | |
|---|---|---|
| How it trades | Once a day at the closing price (NAV) | All day on the stock exchange, like a stock |
| Minimum to start | Often $0 to $3,000, depending on the fund company | One share, or $1 with fractional shares at many brokers |
| Automatic investing | Easy: set a fixed dollar amount each month | Possible at brokers that offer fractional shares |
| Typical fees on broad index funds | Very low (around 0.02% to 0.05%) | Very low (around 0.03% to 0.05%) |
| Tax efficiency in a taxable US account | Good, but can pay out capital gains | Usually better, thanks to the in-kind creation process |
| Works at any broker | Best at the fund’s own company | Yes, trades anywhere |
Real examples: same index, two wrappers
Fidelity’s FXAIX (a mutual fund) and Vanguard’s VOO (an ETF) both track the S&P 500. Their expense ratios are tiny (about 0.015% and 0.03%), and their returns differ by only a few hundredths of a percent a year. See our full comparison of FXAIX vs VOO. The same idea applies to Vanguard’s total market funds: VTSAX vs VTI hold the same stocks in two different wrappers.
Which one should you pick?
- Pick an index ETF if you invest in a taxable brokerage account, want to trade at any broker, or are starting with a small amount.
- Pick an index mutual fund if you want to automate a fixed dollar amount every month and your broker is the fund’s own company (for example, Fidelity funds at Fidelity).
- Inside a 401(k), IRA, TFSA or ISA, the tax difference disappears, so use whichever low-cost index option your account offers.
- Avoid actively managed mutual funds with high fees unless you have a clear reason. Most fail to beat their index over long periods.
New to ETFs? Start with what an ETF is, then read what the S&P 500 is and how a brokerage account works.
See exactly what a higher fee costs you with our investment fee calculator.
Estimate the tax when you sell with our capital gains tax calculator.
FAQ
Can an ETF lose money?
Yes. It holds investments that go up and down, and the ETF falls when they do.
Is an index fund the same as an ETF?
No. An ETF can be an index fund, but an index fund can also be a mutual fund.
This article is for general education and is not financial or investment advice. Figures and rules change, so check current information and consider speaking with a licensed professional before you act.
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Frequently asked questions
Is an ETF the same as an index fund?
Not exactly. Most ETFs are index funds, but some ETFs are actively managed, and many index funds are mutual funds rather than ETFs. “Index” describes the strategy; “ETF” describes how the fund trades.
Are index funds or ETFs better for beginners?
Both work well. A broad, low-cost index ETF is often the easiest starting point because it trades at any broker and many brokers let you buy fractional shares with as little as $1.
Do ETFs pay dividends?
Yes. Stock ETFs pass along the dividends of the companies they hold, usually every quarter. You can take them as cash or reinvest them automatically.
Are index funds and ETFs the same thing?
Not exactly. Both can track an index. An ETF trades on an exchange during the day like a stock, while an index mutual fund is priced once a day.
Which has lower fees, an index fund or a mutual fund?
Index funds and index ETFs usually cost less than actively managed mutual funds. Compare the management expense ratio before you buy.
Which should a beginner choose?
A broad, low-cost index ETF or index fund is a common starting point. Pick the one your account and broker make easiest to buy regularly.
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