Passive investing has become increasingly popular, but the differences between ETFs and index funds are often overlooked, writes UK wealth manager Hargreaves Lansdown.
In theory, ETFs should perform better than index funds, however this isn’t always the case, the firm says, adding that the battle of the trackers comes down to individual preference and the type of investor.
Danielle Farley, passive investment analyst, Hargreaves Lansdown, says: “There’s been a huge shift towards passive investing in recent years, with passive investments dominating flows. In 2024, European domiciled passive funds saw net inflows of EUR307.6 billion, a new record high, versus EUR150.5 billion inflows for active funds. So, it’s no surprise that ETFs and index funds have come up against each other.
“Intraday trading makes ETFs more flexible and allows investors to react quicker. This might be a valuable attribute for investors willing to take shorter-term action or risk.
“When it comes to transparency, ETFs have the upper hand by disclosing their holdings daily. This might appeal to more engaged or, again, shorter-term traders.
“ETFs use in-kind transfers, which involves exchanging securities for ETF shares rather than cash. This is more tax efficient and reduces costs, so ETFs generally have lower management fees versus index funds. But they do come with trading costs so the total cost of ownership should be considered.
“Index funds have a single valuation point which is suitable for most investors who take a longer-term investment approach.
“Unlike ETFs, index funds aren’t required to disclose their holdings daily, but not all investors need this level of transparency and may value simplicity over granularity.
“Index funds typically avoid trading costs, such as dealing charges and spreads, so there’s less for investors to consider compared to investing in ETFs.
“In theory, ETFs should perform better than equivalent index funds because of their tax efficiencies and lower fees. In practice though, there are different factors at play that can impact performance. And different fund managers will use different techniques to keep costs down and performance as close to the index they’re tracking as possible.
“The battle between ETFs and index funds comes down to individual preference and what you value as an investor. More active traders may prefer ETFs, but making shorter-term investment decisions can come with additional risk. For long-term investors, index funds can be a suitable option for the core of an investment portfolio.”
