How ETFs and index funds intersect

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With the volatility in the global markets and rising inflation, you may want to diversify your existing portfolio, and exchange-traded funds, known as ETFs, are generally low cost, and allow you to purchase a blend of stocks in one basket of securities, like a mutual fund.

“You can purchase broad market funds, tied to the S&P 500 Index, or narrower ones, that provide a lower risk profile focused on dividend-paying companies,” said Todd Rosenbluth, head of research at VettaFi.

While many ETFs track an underlying index like the S&P 500, Rosenbluth explained there are many more targeted ETFs focused on companies that demonstrate growth traits or pay dividends. In contrast, index mutual funds tend to focus on just broad market exposure. With ETFs, investors can better tailor their portfolios to fit their risk profile.

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ETFs versus index funds

David Auerbach, managing director of Armada ETF Advisors, said an index fund is a great way to get exposure to a variety of stocks in one wrapper while an ETF provides a more direct way to play a basket/index of securities.

“This is a deeper conversation and there is a lot of research regarding index funds versus ETFs,” he said.

An active ETF is not necessarily copying an index like the S&P 500 or Nasdaq 100, Auerbach said.

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“An index fund is a broad-based basket of securities tied to ‘an index’ that is either proprietary and unique or commonly known – like the S&P 500,” Auerbach continued. “The key is active versus passive and when the portfolio is rebalanced.”

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EFTs, mutual funds and index funds

Greg McBride, Bankrate’s chief financial analyst, explained that an index fund can be a mutual fund or ETF.

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The mutual fund trades once per day at a given price, McBride said, while the ETF is traded throughout the day on an exchange at ever-changing prices.

“The ETF version tends to have lower expenses and with the proliferation of commission-free trading, is increasingly the preferred vehicle for individual investors,” he said.

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