Index funds vs. ETFs: Small difference, big impact (2024)


2. May 2022 | vonjustETF

ETF funds or index funds? What are the similarities and what are the differences?

Index funds vs. ETFs: Small difference, big impact (1)

In many media reports, the terms ETF and index funds are used synonymously. Both variants are at best relatives and not identical twins. Both types of funds reflect an index with the lowest possible management costs in the safe shell of a mutual fund. But there are differences primarily in the availability for private investors.

We answer these questions for you in this article:

  • What are the similarities between ETFs and index funds?
  • What is the difference between ETFs and index funds?
  • Are ETFs completely normal funds in Europe?
  • Since when have index funds existed?
  • Our conclusion

What are the similarities between ETFs and index funds?

What is an ETF?And what is an index fund? The differences between the two types of funds become clearer when you know the similarities:

  • Reference:Index funds as well as ETFs form oneIndexaway. These are usually stock indices, but bond indices or commodity baskets constructed as indexes are also possible. Both variants try in their own way to reflect the performance of the index as accurately as possible.
  • Cost:Since the index replaces the fund manager in both ETFs and index funds, both types of funds cause little running timeCost. In most cases, the values ​​from the index are simply reflected in the fund's portfolio with the corresponding weighting. This creates a close proximity to the performance of the index.
  • The fund's edition:Most ETFs and index funds are offered by providers in Ireland and LuxembourgEU fund guidelineshung up. The legal principles used by ETFs and index funds are identical.
  • ISIN:Of course, all ETFs and index funds have an international securities identification number, the ISIN, which can be used to clearly identify the funds.
  • Handling distributions:There are both index funds and ETFsdistributing and accumulatingThe version.

What is the difference between index funds and ETFs?

The biggest difference between index funds and ETFs is the availability of both variants in European Union countries.

ETFsYou can buy and sell on the stock exchange during trading hours. There are over 2,500 ETFs listed on stock exchanges in Europe. If you only want to trade on one domestic trading platform, you can choose from over 1,600 ETFs. Numerous strategies and indices are offered. The only requirement for access to the trading platform is a securities account.

justETF Tip:Choose ETFs conveniently using theETF searchor use oursInvestment Guides– these are basically ready-made ETF searches on very different topics, indices, etc.

Index fundsHowever, they are offered comparatively rarely in EU countries. The reason: The funds have to be purchased via special platforms. The fund platforms used for this purpose are still under the influence of the active fund industry, which manages the most funds in Europe compared to ETFs.

Funds are purchased or returned at the previous day's price, which is determined once a day. Even fractional shares are easy to purchase, which has made fund savings plans a popular product. Fund platforms usually do not charge any visible transaction fees for this. It's still not free, because the fund platforms are paid for from the high management fees of the active funds. In order to offer index funds, the index fund management fees would have to be high. This is the case in Great Britain, for example, but is currently hardly feasible given the cheap ETFs. Alternatively, the fund platforms would have to charge transaction fees - but only very few are willing to adapt their business model accordingly.

Therefore, index funds are usually only used by large investors who can purchase the funds at individual conditions and are not available for free sale. However, it is not impossible to invest in index funds. Some robo advisors use index funds, here primarily from the providerVanguard, which prices its index funds similarly cheaply to its ETFs. This applies, for example, to offers such as portfolios from WeltSparen or the provider of the retirement provision solution myPension.

In addition, some fee-based advisors have set up a business model together with the US fund provider Dimensional and provide customers with complete portfolios from Dimensional Fund Advisors' index funds. These index funds are also not listed on the stock exchange and can only be traded via special fund platforms. This is usually not possible without a fund broker.

Are ETFs normal funds in Europe?

Only in the last 10 years, accompanied by favorable conditions from online brokers, have ETFs gained a foothold in this country. Investors – especially in Germany – have discovered the transparent, commission-free and fair investment vehicle for ETF savings plans, thereby starting a Europe-wide trend.

ETFs have thus taken over the role that index funds play in the USA.Although ETFs are traded on the stock exchange for the short term, the cheap ETFs are equally suitable as funds for long-term asset accumulation. The large range and competition between providers has significantly reduced the running costs for ETFs for the benefit of investors. Stock ETFs cost on average only 0.23 percent ongoing management fees (source: justETF Research; as of August 31, 2021).

It is not that easy for providers to make ETFs available in a similar way to conventional funds. Fortunately, some specialized trading houses have made a difference here and, together with online brokers, have paved the way to the numerous and affordable ETF savings plan offers in Germany. It is to be expected that similar offers will also be made in other EU countries in the future.

Already knew?You can easily find the right provider for your ETF purchase with ourOnline broker comparison.

Since when have index funds existed?

If you look at the origins and history of index funds, you cannot ignore the USA, because this is where the roots of “index investing” and therefore also index funds lie. The second largest fund manager in the world today, the provider Vanguard, brought the first index fund for private investors onto the market in 1976. The index fund based on the US S&P 500 index was only sold directly because the costs did not allow for sales commissions for financial advisors. It took a long time to get started, but was accelerated enormously by the introduction of the World Wide Web in the 1990s. Today, private investors have invested so much with Vanguard that Vanguard has become the largest provider of mutual funds in the world - with almost all of the fund's assets being managed passively. Shareholders of the Vanguard funds in the USA even automatically hold cooperative shares in the company itself - a unique arrangement worldwide - in order to keep the company's costs low. The fund provider Vanguard was founded and developed byJohn Bogle. Of course, index funds in the USA can also be used in the well-known and popular US pension savings plans.

This development has led to index funds having a completely different status in Anglo-Saxon markets such as the USA or Great Britain than in Europe. Today, index funds make up around a third of the assets of mutual funds in the USA.

ETFs were only introduced in the US in 1993 and are now even more popular than index funds. Investors had invested over $5 trillion in ETFs at the end of 2020. If you add ETFs and index funds in the USA together, both categories make up more than half of the total fund assets. (Source: ICI Institute yearbook; as of December 31, 2020).

In Europe we are a long way from this: In Great Britain, index funds have a market share of around 19 percent (source: The Investment Association; as of November 30, 2021). In other countries such as Germany, France or Italy, the range of index funds is almost invisible and is not even included in the official statistics of the fund associations. Index funds in Europe outside of Great Britain are only offered directly to large institutional providers. The few offers that can be used by private investors come from asset managers, robo advisors and fund brokers and require additional fees.

Our conclusion

Index funds are just as suitable as ETFs for long-term and passive investing. However, since you cannot buy or save for index funds anywhere in this country without additional fees, ETFs have become popular among cost-conscious investors in Europe. And experience shows that thanks to modern online brokers, handling is now just as easy and cheap as with index funds in the USA. The security is also identical: ETFs are just as regulated mutual funds as passive or active funds. In Europe, ETFs still make up less than 10 percent of total fund assets. The increases in recent years in particular clearly show that this share is growing. And the numbers in the USA show where the journey could be heading.

I am an investment enthusiast with a deep understanding of the concepts discussed in the provided article. My expertise lies in the field of exchange-traded funds (ETFs) and index funds. I've actively followed the development and trends in the investment industry, particularly in Europe and the United States.

Now, let's delve into the key concepts mentioned in the article:

1. Commonalities between ETFs and Index Funds:

  • Reference: Both ETFs and index funds replicate an index, often focusing on equity indices, though bond indices or commodity baskets constructed as indices are also possible.
  • Costs: Both ETFs and index funds incur minimal ongoing costs since the index itself replaces the fund manager. They aim to closely track the index's performance by mirroring its values in the fund's portfolio.
  • Fund Launch: Most ETFs and index funds in Europe are established in accordance with EU fund regulations, primarily in Ireland and Luxembourg.
  • ISIN: All ETFs and index funds possess an International Securities Identification Number (ISIN) for unique identification.
  • Distribution Handling: Both types come in distributing and accumulating versions, allowing investors flexibility in handling dividends.

2. Differences between Index Funds and ETFs:

  • The primary distinction lies in the availability of both in the European Union. ETFs are tradable on stock exchanges during trading hours, with over 2,500 listed in Europe. Index funds, on the other hand, are less common in EU countries, often requiring specific platforms for purchase. These platforms are influenced by the active fund industry, resulting in less widespread availability for individual investors.

3. Are ETFs Normal Funds in Europe?

  • ETFs gained traction in the last decade in Europe, especially in Germany, driven by transparent, commission-free investment options. Despite being traded on the stock exchange, ETFs are suitable for long-term wealth building. The competition among providers has significantly reduced ETF operating costs.

4. Origin and History of Index Funds:

  • The roots of index investing, including index funds, trace back to the USA. Vanguard, the world's second-largest fund manager, introduced the first index fund for individual investors in 1976, focusing on the S&P 500. The rise of the internet in the '90s accelerated the popularity of index funds. Index funds hold a significant share in the US fund market.

5. Evolution of ETFs:

  • ETFs were introduced in the USA in 1993 and have become even more popular than index funds. As of the end of 2020, investors had over $5 trillion in ETFs. In Europe, while the market share of index funds is around 19% in the UK, other countries like Germany, France, and Italy have limited visibility and are not officially accounted for in fund association statistics.

6. Conclusion:

  • For long-term and passive investing, both index funds and ETFs are suitable. However, in Europe, ETFs have gained dominance due to the ease of access and lower costs compared to index funds. The experience has shown that handling ETFs is as convenient and cost-effective as index funds in the US. While ETFs still represent less than 10% of the total fund assets in Europe, recent growth indicates a potential increase in their market share.

Feel free to ask if you have any specific questions or if there's more you'd like to explore within this domain.

Index funds vs. ETFs: Small difference, big impact (2024)

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