Index Fund vs. ETF: Can a Fund Be Both?

Yes, a fund can be both an index fund and an ETF. "Index fund" describes how a fund invests: it tries to follow an index. "ETF," short for exchange-traded fund, describes how its shares are bought and sold: on an exchange, during the trading day. Because the two labels answer different questions, one fund can fit both. [1][2]

Imagine you open an investing app and see an index fund on one screen and an ETF on another. The labels seem to ask you to pick a side. Then a third fund calls itself an index ETF. Once you separate the two ideas, the comparison gets much easier. In the video above, we follow one beginner, Claire, through three imaginary funds. This article walks through the same lesson.

What a fund is, before any label

A fund pools money from many investors and owns a collection of investments. Buying a share gives you a stake in that collection. Depending on the fund, the investments could be stocks, bonds or a mix. Every label that follows describes something about that collection or about how you get in and out of it.

Label one: the investment approach

Claire's first imaginary fund follows an index of large American companies. Think of an index as a measuring system with a rulebook. The rules decide which companies belong and how much each one counts, and the index measures how that group performs.

The index itself is only a measurement, so Claire cannot buy it directly. She buys shares in a fund that owns investments and tries to follow the index. This approach is called index investing. The manager might hold every investment in the index or a representative sample. The goal is to track the index closely, although costs and differences in holdings can make results drift apart. [1][3]

Claire's second imaginary fund works differently. Its manager chooses investments using research and judgment, within the fund's stated objective. That is active management. An active manager may try to beat a benchmark; whether that happens is a separate question from what the manager intends. [1]

So the first label answers one question: does the fund follow an index, or does a manager actively choose its portfolio?

Label two: the fund structure

The second label is about how you buy and sell.

Mutual fund. Your order receives the next calculated price after the fund properly receives it, subject to the fund's rules. That price is usually calculated once a day, after the market closes. It is called net asset value, or NAV: what the fund owns, minus what it owes, divided by the number of shares. Seeing yesterday's NAV on a screen does not mean today's order will get yesterday's price. [1][4]

ETF. You use a brokerage account to trade shares on an exchange during market hours. The market price can move throughout the day, and it can sit above or below the fund's NAV. [1][2]

That trading flexibility tells you how a transaction works. It does not tell you what the fund owns or how risky those investments are.

Four combinations, two questions

Claire's three imaginary funds now make sense:

Fund A: follows the large-company index, and is a mutual fund (an index mutual fund).
Fund B: follows the same index, and is an ETF (an index ETF).
Fund C: an ETF whose manager actively selects investments (an actively managed ETF).

A and B share an approach. B and C share a trading structure. An actively managed mutual fund would complete the fourth combination.

At a glance:

Index mutual fund: follows an index; bought or sold at the next calculated NAV
Index ETF: follows an index; traded on an exchange at market prices during the day
Actively managed ETF: a manager selects investments; traded on an exchange at market prices
Actively managed mutual fund: a manager selects investments; bought or sold at the next calculated NAV

This is also why not every ETF is an index fund. Some ETFs are actively managed. [2][5]

Same index, different costs

Following the same index gives Fund A and Fund B a similar target. It does not promise identical results or identical costs.

Suppose, purely for this example, Fund A has an annual expense ratio of 0.20% and Fund B charges 0.10%. On an average balance of $10,000 over a year, that is roughly $20 versus $10 in annual fund expenses. The difference is $10, before considering other costs or taxes.

Those expenses come out of fund assets. You generally won't receive a separate bill for them, but they still reduce what investors keep. [6]

Now swap the two fee rates and keep everything else the same. The mutual fund becomes the cheaper one on this measure. That is the useful lesson: read the actual numbers. The word ETF doesn't automatically win the cost comparison, and neither does the word index.

The expense ratio isn't the whole bill

A few other costs can matter:

Account and transaction charges. Check what your brokerage or fund company charges to buy, sell or hold.
The bid-ask spread. With an ETF, the gap between the price buyers pay and the price sellers receive can create a trading cost. [5]
Sales charges. Some mutual funds charge a sales fee (a load); others don't. The fund's prospectus fee table shows it. [6]
Taxes. In a taxable account, many ETFs distribute fewer capital gains than comparable mutual funds, but an ETF is not automatically tax-free. Inside an IRA that potential advantage is not the same consideration, because the account's own tax rules apply. [1]

What the labels leave out

There is one more question to ask: what does this index actually cover? An index of one industry and an index spanning many industries can both produce index funds, and they offer very different exposures.

Even a fund with many companies may put a large share of its money into a small number of them. A long list of holdings doesn't mean every company has an equal influence. And if the investments lose value, the fund can lose value too. Following a rulebook doesn't prevent losses. [4][5]

A checklist for comparing two funds

Read a fund description with four questions in mind:

What does it own? Look at the index it follows, or its stated objective, and its largest holdings.
How are those investments selected? Index rules or a manager's judgment?
How do I buy and sell? Next calculated NAV, or exchange trading at market prices?
What are the costs? Expense ratio, plus any sales charges, spreads, account fees and tax effects.

To practice, pick a fund you are researching. Write down its investment approach and its structure as two separate notes. Then find its objective and fee table in the fund documents. You don't have to choose anything to practice reading them.

Our companion guide, How to read an ETF before you buy it, walks through those documents with one example, from holdings to the cost of a trade. For the trading and pricing differences in more depth, see ETF vs mutual fund: what is actually different?

FAQ

Is every ETF an index fund?

No. Many ETFs follow an index, but some are actively managed. Check the fund's stated objective and strategy. [2][5]

Is an index ETF cheaper than an index mutual fund?

Not automatically. Compare each fund's expense ratio and other costs. In our example, swapping the two fee rates made the mutual fund the cheaper one.

Do two funds that track the same index perform the same?

They have a similar target, but costs and differences in holdings can make results drift apart. [1]

Can an index fund lose money?

Yes. If the investments in the index lose value, the fund can lose value too. [4]

This is for educational purposes only, not financial advice.