(NJ) -- Q. What’s the difference between an index fund and an exchange-traded fund? How do I know which is better for me?
— New investor
A. We’re glad you’re asking rather than invest in something you don’t understand.
An index fund is a type of mutual fund, while an exchange-traded fund, or ETF, is a different kind of basket of securities.
Both ETFs and mutual funds collect investor money and buy securities, which are then managed according to the fund’s goal, said Jim McCarthy, a CFP with Directional Wealth Management in Rockaway.
He said these investment products may seem similar, but there are important differences to understand.
First, ETFs trade like stocks and can be bought or sold throughout the trading day, while mutual funds settle after the market closes.
Then there’s the cost to you.
“One of the biggest differences is the investment minimums required in order to invest in the product, and a mutual fund usually has a higher investment minimum as compared to an ETF,” McCarthy said.
“Expense ratios should also be considered because expenses can be a drag on performance in the long run.”
Another key difference is the taxation of each product.
He said mutual funds usually have a higher tax consequence compared to an ETF.
“This is important because it may make sense to pick an ETF or a mutual fund depending on the type of account that the fund will be held,” he said.
Another difference is that you can make automatic investments into a mutual fund but you cannot with an ETF, he said.
