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Index Funds vs. ETF's



What's the difference between an Index Fund and an ETF. You've heard me go on and on about index funds, but wtf are ETF's?!?! In some ways if you understand Index Funds, which you should by now since I've spent a whole lotta time talking about them, then you understand ETF's. I like to think of ETF's as a hybrid between Index Funds and Stocks. Although they are quite similar and can both be useful to the layman investor, there are some key differences which we'll talk about below.


INDEX FUNDS...

When you invest in an index fund, you're buying into a basket of assets (Stocks, Bonds, etc.). If you were to buy Vanguards Total Market Index Fund (VTSMX) then you would be buying into the entirety of the U.S. Stock Market. Now, an index fund has some interesting features to it, which could be seen as pros or cons depending on your situation and taste. First of all, there is a minimum investment requirement. In the case of VTSMX, you need to have an initial investment of three thousand dollars. Once you fulfill that requirement, then you can put in what you like periodically, but first you need to fulfill that minimum investment requirement. Also, if you want to buy or sell into an index fund you have to wait until the end of the trading day, which is 4 p.m. (EST). I'm not exactly sure why this is the case, but it is, and therefore can cause some liquidity issues for you if you're in desperate need of some cash. I'm not advocating people being trigger happy with liquidating, but emergencies do come up. Lastly, if you were to buy an Index Fund through a broker like E*trade, then you pay no commission fees or transaction fees to the broker, which can be very beneficial for your long-term returns.


ETF'S...

ETF stands for exchange-traded fund and is a similar investment vehicle to Index Funds except for a couple of key areas. ETF's follow the same principle as Index Funds in that they are passively managed and incorporate an indexing strategy. They track an index (an index being, for example, a particular sector of the economy like Tech, or Pharmaceuticals) and try to mirror the performance of that index. You can also have an ETF that tracks the Total Stock Market Index, which is what Vanguard also offers through their Vanguard Total Stock Market Index ETF (VTI). VTI is the ETF version of VTSMX described above.


THE DIFFERENCE BETWEEN THE TWO...

Now what's the difference between the Index Fund and ETF and why choose one over the other? Well, unlike an index fund, an ETF trades like a stock. Investors do not have to wait until the end of the day to trade an ETF. They can do it whenever they want between 9 a.m. (EST) - 4 p.m. (EST). Now this makes an ETF a more liquid asset than an index fund. Also, like a stock purchase, investors can buy shares of an ETF instead of having to meet any minimum investment requirements. You don't need a minimum of three thousand dollars to invest in the ETF version of Vanguard's Total Stock Market Index Fund ETF (VTI). So for investors, like myself, who don't have a lot of money to initially invest with, an ETF version of the Total Stock Market Fund could be a great way to go. One day, when we eventually grow our assets, or our incomes to meet the minimum investment requirements of an Index Fund, then we can switch from the ETF version to the Index Fund. Or you can stay in ETF's if you want, although you have to have more discipline when investing in them. Remember, you can buy and sell ETF's anytime during the trading day, so if you are someone that can get overly emotional or trigger happy, beware.


When you look at the landscape of investment vehicles, there seems to be an Index Fund and an ETF equivalent for just about every sector of our economy. There are even Index funds and ETF equivalents for precious metals like gold and silver. The landscape is vast and it is always up to the investor to decide how to navigate. The way is your own to choose, but the more knowledge you have the more informed decisions you can make. As I always say, Index Funds and/or ETF's now, are a great place to start learning about the fundamentals of investing, however, they are in no way the only place to invest. Continue to upgrade your Financial IQ so that you can adapt to the changing times. Grow multiple sources of income so that you no longer have to worry about a job to keep you afloat. Stay the course and no matter what keep learning, keep reading, and keep upgrading yourself!

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