Investing Basics

ETFs or index funds

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If you are exploring the entire spectrum of investment types, you’ll quickly find that the similarities between ETFs like Invesco QQQ that track an index, and index mutual funds are far greater than their differences. They both:

  • Provide a simple and convenient way to potentially diversify a portfolio of investments. Rather than having to buy tens or hundreds of individual stocks or bonds to diversify, you can purchase shares in a single ETF or index fund to help achieve the same goal.
  • Offer professional investment management. Even though they’re structured to track a particular index, ETF and index fund portfolio managers are there to oversee the portfolio and make adjustments.
  • Are typically lower cost solutions because they’re passive (rather than actively managed) investments.
  • Give you a wide range of investment choices—from tracking domestic and international stock indexes to bond, market sector and even commodity indexes.

Compared to investing in individual stocks and bonds or higher-cost actively managed mutual funds, ETFs and index funds may offer long-term investors a simple, cost-effective way to save for the future. But there are a few differences between these two types of investments that investors will want to consider.

Potential ETF advantages

  1. Trading flexibility: Mutual funds (including index funds) are priced only once each day at market close. Whether you place an order to buy shares first thing in the morning or right at market close, that daily price is what you’ll pay. ETFs, on the other hand, are bought and sold on an exchange much like stocks. That means they can be traded throughout the day, which affords a lot more flexibility for investors who want to take advantage of intraday market movements—especially during times of excessive volatility.
  2. Greater tax efficiency: Thanks to their structure, ETFs are often a bit more tax efficient than index funds. While the tax treatment of both is the same (subject to capital gains and dividend income taxes), ETFs generally require fewer ‘taxable events’ and it’s exceedingly rare for an index-based ETF to have to pay out a capital gain. When you sell index fund shares, you’re selling them back to the fund itself—which in turn sells stocks from its portfolio to buy back those shares. Essentially, the fund is constantly buying and selling shares of the stocks that comprise the index it’s tracking as investors enter and exit the fund.
  3. Lower minimums: Many index funds require initial investment minimums of around $1,000 to $3,000.1 While not a barrier to many investors, these minimums might prevent some investors from being able to invest in multiple funds to further diversify their portfolio. With an ETF, however, typically all that is needed to make an investment is enough to cover the cost of a single share.

One important note regarding ETFs is that (much like stocks) there’s often a price discrepancy between the ‘bid’ and ‘ask’ prices.  (The bid price is the maximum price a buyer is willing to pay, while the ask price is the minimum price a seller will accept.) With large ETFs like the Invesco QQQ ETF, this discrepancy is usually small. For niche ETFs that aren’t heavily traded, however, the bid/ask spread can be quite large.

Because the distinctions between these two similar passive indexing approaches are subtle, choosing either an index fund or an ETF often comes down to a matter of personal preference, comfort, and availability.

Important Information

  • 1

    Morningstar Mutual Fund Screener, May 2021

How to invest in QQQ

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