Index Funds vs ETF Investing | Stock Market For Beginners

Introduction to funds watch from 0:00

In today's video we're going to compare index funds versus the ETF. Which one is the best? I'm going to answer for you: how are index funds and ETFs similar, how are they different, and how do you know which one is right for you? So essentially, are you an ETF type of person or are you an index fund type of person? So I'm going to help you answer that. Okay, so I'm going to tell you the truth. The truth is that they are more in common than, that they have more similarities than differences, but I want you to be aware of the differences that could make an ETF or an index fund a deal breaker for you.

First I want to say this, I want to get this out of the way, because this is very important. If you don't know about index funds or ETFs, then you were at the wrong video, my friends, and then I leave a link down below to an index fund for beginners video. So please check that video out first. Otherwise, in this video you're going to get confused, you're going to get discouraged like a lost puppy really quickly, and I do not want that to happen to you. Okay, with that being said, if you're still here, that's good. I wanna, I wanna demonstrate to you what is going on with an index fund. So you

How index funds work watch from 1:06

can think of it like this. Let's say that you, me, my brother, your neighbor, and my Uncle Bob, we're all pooling money together, and with this pool of money we're gonna buy all the stocks in the S&P 500. Let's just say we do that, and let's just say that you want out. When you want to cash out your portion, the fund has to sell some of its holdings to pay you out. Now let's

How ETFs work watch from 1:32

compare this to an ETF. So with an ETF, an exchange traded fund, you could think of it like this. Let's just say that you bought all the stocks in the S&P 500, and you package them all up into one bundle, and you did that 10 times, and I say to you, hey, can you sell me one of those? And you're like, yeah, sure, and I buy it from you. So it's simply traded from you to me, like a stock. So I hope that helps to clarify what is going on. An index fund is a collection of

Similarities of funds watch from 2:06

securities that are financed by a pool of investors, an ETF is a collection of securities that are traded between investors. So that's it, that's the difference. But there are a lot of similarities, and let me tell you what those are. Both an index fund and ETF offer you a low-cost solution, diversification, and a proven track record. So index funds and ETFs, they're both passively managed. This means that there's no human that is actively choosing what to invest in. Therefore index funds and ETFs are low cost; they have a low expense ratio. Now, both index funds and ETFs, they will give you diversification, because they hold a variety of assets. And index funds and ETFs generally outperform active fund managers over a longer period of time. Now I want to tell

Key differences overview watch from 2:56

you the differences, and this will help you determine which one is better for you. So the four biggest differences between an index fund and ETFs are: liquidity, minimum investment requirements, expenses and fees, and taxation. So let's get started

Liquidity and investment watch from 3:14

with liquidity. You can buy and sell ETFs throughout the trading day, like a stock. With an index fund, you can only buy or sell at the end of the day. Therefore an ETF is more liquid. So this probably will not make a big difference for most long-term investors, but it does matter if you're going to do any day trading or shorter duration moves. Now moving on to minimum

Costs and fees watch from 3:38

investment requirements. So generally an ETF will have a lower minimum investment requirement when you compare it to an index fund. So for example, you can buy as little as a single share of an ETF. In some cases you can even buy fractional shares of an ETF. But with some index funds, they're going to impose a minimum requirement. It could be a thousand dollars, could be two thousand dollars, or even more. Now, when it comes to expenses and fees, both index funds and ETFs are low-cost investments. That's because both are passively managed. Previously ETFs were known to carry lower expense ratios compared to index funds, but that gap has been closing, and the expenses for index funds and ETFs, they're now quite similar.

So you're going to see expense ratios in the 0.05 percent to 0.02 percent range, which is a fraction of one percent, which is a very low cost solution. And of course we have to consider taxation.

Tax efficiency watch from 4:38

ETFs are more tax efficient compared to index funds. That's because of their structuring. So I previously demonstrated to you how they're structured, and that's structuring, it has tax consequences. So essentially, with an ETF you're selling to another buyer, and the cash comes directly from that buyer. To cash out of an index fund, you have to redeem it from the fund manager, and the fund manager will have to sell some of the holdings to get the cash to pay you out. So if there is a gain on the sale, that gain is passed on to all investors of the fund. That means that you could end up with a tax bill even if you don't sell a single share.

So ultimately, assets are bought and sold every time an investor enters or leaves an index fund, and anytime there's a capital gain, every investor that's part of the fund will need to pay capital gains tax. Now I want to be very clear with you on this topic of taxation, because I don't want this to scare you. So this is going to be in relation to how much money that you have in the index fund. So if you have very little money in the fund, then don't expect the tax consequences to be significant. But if you do have a lot of money in the index fund, then yes, it could be a decent amount. Now let me give

History of index funds watch from 5:54

you my opinion on which one is better, an index fund or an ETF, but I want to tell you this story to help you understand the situation, the whole situation. So the index fund was created in 1975 by John Bogle, who went by the name of Jack. So Jack Bogle was the founder of the Vanguard group. Bogle created the index fund in 1975 so that everyday investors could compete with the pros.

Rise of ETFs watch from 6:20

So that was 1975. It took a few years for index fund investing to catch on, but eventually it gained traction. So 18 years passed by, it's 1993. State Street Global launches their S&P 500 ETF called the SPDR, is referred to as the spider. But this wasn't the first ETF. This was preceded by the Toronto ETF in 1990, among others. But ultimately the ETF is an improvement of an index fund. It's like an index fund 2.0, and that's why ETFs have been gaining in popularity very quickly. 1993, the ETF market basically didn't exist. 2002, there are over 100 ETFs. 2009, over 1,000 ETFs. Currently, we're close to ten thousand, and right now there's a competition for your money between index funds and ETFs. So Jack Bogle, the

Conclusion and opinion watch from 7:15

inventor of index funds, he's scoffed at ETFs. He said that they're for speculators and [for] rapid trading. Bogle said the financial institutions use ETFs to hedge, and that less than 20 percent of ETFs are held for the long term, and there's a lot of truth to that. But honestly, you're free to use your ETFs and or your index funds, you know, however you please. You know, I'm not going to judge you. Now let me tell you what I think. My opinion is that an ETF is an upgraded version of an index fund, and here's why. If you're on a tighter budget, an ETF may be better for you, if you have less money to invest up front.

So I'm referring to the higher minimum requirements. So ETFs, yes, they do have a better tax structuring, and that's going to give you a greater control of claiming gains or losses. And because you can sell, so you can buy or sell an ETF throughout the day, so if that need ever arose, I'm guessing in most situations that it would not, but if it ever did, that you could take an advantage of that situation of any major price movements throughout the day, and that is a benefit that you cannot have or do with an index fund. However, some of these ETF advantages, they might not make a meaningful difference to you, especially if you're a long-term investor.

So I want to be clear that I do like index funds, but if I had to choose, then I would go with an ETF. But that is just my opinion. But if there's a, if there's a particular index fund that does not have a competing ETF, then yeah, I would buy, you know, that index fund. So that's just the way I see it. So that's my opinion, and let me know what you think, and please read the comments to see what other people are saying or thinking as well. I hope that this has been helpful, and please check out our other videos, including index funds versus stock picking, index funds for beginners, and we'll also give an updated list of the top index funds and ETFs. Please Subscribe, and thank you for all the support, and I wish a very nice day. Take care.