The question we’re most often asked in our guise as passive investing [1] nerds is: “Should I buy index funds or Exchange Traded Funds (ETFs) as my tracker [2] vehicle of choice?”
A quick recap:
- An index fund is a unit trust (or OEIC [3]) whose portfolio is designed to track the return from a particular market index [4].
- An ETF is a security that is again designed to track the return from a particular index. ETFs trade on stock markets like any other share, and their price moves up and down during the trading day.
So are there different situations – or types of investor – for whom an index fund trumps an ETF, or vice versa?
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This isn’t new territory for Monevator. We’ve looked before at the differences between ETFs and index funds [6]. We’ve even done a huge multi-part guide to buying the best index tracker [7] on a fund-by-fund basis.
However we’re now going to break it down into a bite-sized battle of the trackers.
Over a half-a-dozen small posts, we’ll look at each of the aspects you need to consider in your quest to find the best funds for you.
We’ll start by explaining why you should buy index funds if simplicity is your most important consideration!
Index funds are simpler than ETFs
If simplicity is paramount to your investing life then index funds are the way to go.
Like the mortice lock or the four-legged chair, index funds are straightforward products that do a good job and aren’t subject to the constant product innovation and morphing that can make ETFs something of a minefield .
Index funds have been available since 1975 with nary a whiff of financial scandal that entire time.
With index funds you can skip complications that affect ETFs like:
- Synthetic index replication [8] that exposes you to counterparty risk.
- NAV premiums and discounts that affect cost calculations.
- Wide bid-offer spreads [9] that make illiquid ETFs more costly.
- Dealing fees (unless you choose Vanguard funds [10]).
- Using limit orders to control your buy/sell price.
You don’t need to understand any of that with index funds, and you can buy index funds cheaply [11] through a fund supermarket or online broker.
Part two: Which vehicle is best when it comes to cheaper costs [12]?
Take it steady,
The Accumulator