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ETF vs. Index Fund: The Key Differences

Exchange-traded funds and index funds are great for new investors and experts alike, but there are a few differences to note before you start investing.

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The main difference between ETFs and index funds is that ETFs can be traded throughout the day like stocks, whereas index funds can be bought and sold only for the price set at the end of the trading day.

For long-term investors, this difference isn’t of much concern. Buying or selling at noon or market close will likely have little impact on the value of the investment in 20 years. However, if you’re interested in intraday trading, ETFs may better suit your needs. They can be traded like stocks, yet investors can still reap the benefits of diversification.

1) The main differences between ETFs and index funds.

Minimum investment: ETFs generally have lower investment minimums.

Capital gains taxes: ETFs are typically more tax-efficient.

Miscellaneous fees: ETFs and index funds can have differing fees outside of their expense ratios.

2) The main things ETFs and index funds have in common.

Diversification: Both can help you create a well-diversified portfolio.

Low costs: Both are based on an index and are generally low-cost.

Returns: Both have strong long-term returns compared with actively managed funds.

Prefer a visual? Watch NerdWallet Editor Alana Benson talk through what to consider when deciding between index funds and ETFs.

Differences between ETFs and index funds

1. The minimum investment required

In many cases, ETFs will have a lower minimum investment than index funds. Most of the time, all it takes to invest in an ETF is the amount needed to buy a single share, and some brokers even offer fractional shares.

But for index funds, brokers often put minimums in place that might be quite a bit higher than a typical share price. If you have only a small amount to invest, consider an ETF with a share price you can afford or an index fund with no minimum investment.

» See which brokers offer index funds with no fees or minimums

2. The capital gains taxes you’ll pay

ETFs are more tax-efficient than index funds, thanks to the way they’re structured. When you sell an ETF, you’re typically selling it to another investor, and the cash is coming directly from them. Capital gains taxes on that sale are yours and yours alone to pay.

To get cash out of an index fund, you technically must redeem it from the fund manager, who then sells securities to generate the cash to pay you. When this sale is for a gain, the net gains are passed on to every investor with shares in the fund, meaning you could owe capital gains taxes without ever selling a single share.

This happens less frequently with index funds than with actively managed mutual funds (where buying and selling occur more regularly), but from a tax perspective, ETFs generally have the upper hand over index funds.

» Ready to get started? See our picks for the best brokers for ETF investing

3. Miscellaneous fees

Index funds and ETFs generally have similar expense ratios, but there may be miscellaneous fees that differ. If your broker charges a commission for trades, you’ll pay a flat fee every time you buy or sell an ETF, which could eat into returns if you’re trading regularly. Some index funds also come with transaction fees when you buy or sell, so compare costs there, too.

When buying ETFs, you’ll also incur a cost called the bid-ask spread, which you won’t see when purchasing index funds. However, this expense is usually very small if you’re buying high-volume, broad market ETFs.

» Related: The best high-dividend ETFs by yield

Similarities between index funds and ETFs

1. Diversification

Both index funds and ETFs can help you create a well-diversified portfolio. For example, an ETF based on the S&P 500 will give you exposure to hundreds of the country’s largest companies. (See a few S&P 500 ETFs here.)

2. Low costs

Index funds and ETFs are typically passively managed, meaning the investments within the fund are based on an index, such as the S&P 500, and therefore have relatively low costs. You can easily find funds with expense ratios under 0.05%. On a $10,000 balance, that would come out to just $5 per year.

This is compared with an actively managed fund, in which a human broker is actively choosing what to invest in, which results in higher costs for the investor. According to the Investment Company Institute, the average expense ratio for actively managed mutual funds is 0.64%

3. Strong long-term returns

For long-term investors, passively managed index funds tend to outperform actively managed mutual funds. Passively managed investments follow the ups and downs of the index they’re tracking, and these indexes have historically shown positive returns. The annual total return of the S&P 500, for example, has averaged around 10% over the last 90 years.

Actively managed mutual funds may perform better in the short term because fund managers are making investment decisions based on current market conditions and their own expertise. But the improbability that fund managers will make consistent, market-beating decisions over a long period can lead to lower returns over time versus passively managed funds. According to SPIVA, 79% of actively managed large-cap U.S. equity funds underperformed the S&P 500 in 2025

Choose your next step

How to invest in ETFs

How to invest in index funds

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