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ETFs & Index Funds

ETFs and index funds explained: how exchange-traded funds work, index funds vs ETFs vs mutual funds, what expense ratios cost you, and how to invest in an S&P 500 fund as a beginner.

These guides explain ETFs and index funds, the building blocks of most long-term portfolios. An index fund tracks a market index such as the S&P 500 instead of trying to beat it. An ETF (exchange-traded fund) is a fund that trades on a stock exchange throughout the day. Many ETFs are index funds, and many index funds are ETFs, which is why the terms get mixed up.

Start here

  1. What is an ETF and how does it work?
  2. Index fund vs ETF: what is the difference?
  3. ETF vs mutual fund: fees, taxes and trading.
  4. How to invest in an S&P 500 index fund.

Key concepts

Expense ratio

The expense ratio is the fund’s annual cost as a percentage of your investment, taken automatically from fund assets. Broad index funds from large US providers often charge well under 0.10% a year.

Example: On a $10,000 investment, a 0.05% expense ratio costs $5 a year, while a 1.00% ratio costs $100. Over decades, that difference compounds into thousands of dollars.

Passive vs active

Passive funds follow an index. Active funds pay managers to pick investments and usually charge more. Long-running studies such as S&P’s SPIVA reports have found that most active funds trail their benchmark index over 10 to 15 years.

Trading and taxes

ETFs trade at market prices during the day; traditional mutual funds trade once a day at net asset value. In the US, ETFs are often more tax-efficient in taxable accounts because of how shares are created and redeemed.

Not all ETFs are simple

Leveraged, inverse and narrow thematic ETFs behave very differently from broad index funds. Leveraged ETFs reset daily and can lose value over time even if the index ends flat.

Risk note

An index fund removes the risk of picking the wrong company, not the risk of the market falling. A fund tracking the S&P 500 can drop sharply in a bear market. See the stocks and ETFs hub for more.

ETFs & Index Funds: frequently asked questions

Is an index fund the same as an ETF?

Not always. An index fund is defined by its strategy, tracking an index; an ETF is defined by its structure, trading on an exchange. Many funds are both, but some index funds are mutual funds and some ETFs are actively managed.

What is a good expense ratio for an index fund?

For broad US or global stock index funds, many investors look for expense ratios below about 0.20%, and many large funds charge under 0.10%. Specialized or international funds can cost more. Compare funds tracking the same index.

Can you lose money in an ETF?

Yes. An ETF's value moves with the assets it holds, so a stock ETF falls when the market falls. Broad funds reduce single-company risk but not market risk.

How do I buy an ETF?

Open a brokerage account, search for the fund's ticker symbol, and place a buy order for a number of shares or a dollar amount if fractional shares are offered. Many investors use limit orders to control the price paid.