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ETF schoolLevel 1Beginner6 minUpdated ETF or index fund?
Two ways to make a passive index investment: the differences in trading, costs and monthly investing.
There are many ways to invest in an index. Two common options are the exchange-listed index ETF and the traditional index fund. Both can track the same or a very similar market. In that case, the biggest difference isn't what you invest in, but how the investment is bought and priced, and what you pay for using it.
This chapter specifically compares a passive index ETF with a passive index fund. Active ETFs have a chapter of their own: Active ETFs →
Same investment idea, different implementation
The index tells you what you invest in. An ETF or a traditional fund tells you how the investment is packaged and how you use it. The same market may be available both as an index ETF and as a traditional index fund, and their contents can be practically identical.
There's one important caveat: the comparison only makes sense if the products track the same or a sufficiently similar market. An S&P 500 ETF and a global index fund are not alternative wrappers for the same investment, because their contents are different. In that case cheaper isn't better. It's a different investment.
The biggest difference: how do you buy and sell?
The practical difference comes from how you trade. An ETF is traded on an exchange during the trading day. Subscriptions and redemptions in a traditional index fund are executed at a NAV calculated according to the fund's rules.
| Index ETF | Index fund | |
|---|---|---|
| Trading | On an exchange | Through the fund management company or a service |
| Price | Changes during the trading day | The fund's NAV |
| Buying | Order | Subscription |
| Selling | Sell order | Redemption |
| Amount invested | Depends on the unit price and the service | Usually an amount in euros |
| Automation | Depends on the service provider | Often very straightforward |
Order types, the spread and how prices form on the exchange are covered in a chapter of their own: Buying an ETF in practice →
Which one is cheaper?
There's no single answer, which is why it's worth rephrasing the question: what is the total cost for the way you invest? The annual fee is only one part of it.
- Ongoing charge
- Possible subscription or redemption fee
- Ongoing charge
- Trading fee
- The difference between the buy and sell price, i.e. the spread
- Possible currency exchange cost
The deciding factor is the trading fee relative to the purchase amount. If the trading cost of an ETF purchase is €5, that's 5% of a €100 purchase and 0.5% of a €1,000 purchase: the same amount in euros, with a completely different weight.
So the annual fee alone doesn't tell you which option is cheaper for you. The amount you invest and how often you buy affect the total at least as much.
Monthly investing: the practical difference
The same pair of products can tip either way depending on how much and how often you invest. Three typical situations:
Depending on the service, you can invest an exact amount in euros automatically in an index fund, without a separate trading order. With small amounts, the purchase fee weighs most heavily on the ETF side.
Monthly investing in an ETF can be cost-efficient if the service provider's pricing and automation suit it. The lower ongoing charge starts to offset the purchase fee.
The relative weight of the trading cost is very small, so a broad selection and a low ongoing charge can count for more in the comparison.
The principles of monthly investing are covered in Level 1: Monthly investing →. The better option also depends on how you invest, not just on which product looks cheaper on paper.
What about taxes?
In Finland, the taxation of both an index fund and an index ETF depends on, among other things, whether the fund distributes returns to the investor or reinvests them within the fund. An accumulating unit reinvests the returns within the fund; a distributing unit pays returns out to the investor.
The detailed tax rules (capital income tax, capital gains and the deemed acquisition cost) are covered in a section of their own: Accounts and taxes →
Which one should you choose?
There's no single winner. The choice depends on what you value, and each priority points you to check something different.
| If you particularly value… | Check in particular… |
|---|---|
| Automatic saving with small amounts | The index fund's minimum amount and fees |
| A very wide product selection | The ETF selection |
| Real-time trading | ETF: exchange trading during the trading day |
| A simple set-and-forget setup | The monthly investing features of both |
| Low total costs | Calculate the total costs; don't just compare the TER |
| A specific index | Which product tracks exactly that index |
An index ETF and an index fund are not opposites. They are two ways to implement a very similar investment strategy. Base your choice on which index you want to track, how much and how often you invest, and the total costs and practical features your service provider offers.
This content is for information purposes only and should not be construed as investment advice or a recommendation. Investing always involves the risk of losing capital. The value of financial instruments and investments can go up or down, and past performance is no guarantee of future returns. The calculators and comparisons are illustrative.
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