DEFINITION of 'Index ETF'

Index ETFs are exchange-traded funds that seek to track a benchmark index like the S&P 500 as closely as possible. They are like index mutual funds, but where mutual fund shares can be redeemed at one price each day, the closing net asset value (NAV), index ETFs can be bought and sold throughout the day on a major exchange. With an index ETF, investors gain exposure to numerous securities in a single transaction.

Index ETFs can cover U.S. and foreign markets, specific sectors or different asset classes (i.e. small-caps, ADRs, etc.). Each asset incorporates a passive investment strategy, meaning the provider only changes the asset allocation when changes occur in the underlying index.

BREAKING DOWN 'Index ETF'

Index ETFs may occasionally trade at a slight premium or discount to the fund's NAV, but any differences will be quickly rubbed out through arbitrage by institutional investors. In most cases, even the intraday prices correlate to the actual value of the underlying securities. Other types of ETFs include leveraged  ETFs, which move like a regular ETF with an added multiplier, or short ETFs, which perform well when the underlying asset tumbles. Index ETFs are constructed from most of the major indexes such as the Dow Jones Industrial Average, the S&P 500 and the Russell 2000.

The fee structure is comparable to the cheapest no-load index mutual funds as measured by the expense ratio, but investors will typically pay standard commission rates for ETF trades. It is often charged when a buy or sell order is made, though many brokers offer a wide selection of commission-free ETFs. 

Index ETFs can be set up as either grantor trusts, unit investment trusts (UITs) or open-ended mutual funds, and will subsequently have some different regulatory guidelines. Most index ETF shares can be traded with limit orders, sold short and purchased on margin.

Advantages of an Index ETF

Like other exchange traded products, Index ETFs offers instant diversification in a tax efficient and cost effective investment. Other advantages of a broad-based index ETF include less volatility than a strategy specific fund, tighter bid-ask spreads (so orders are filled easily and efficiently), and attractive fee structures.

Of course, no investment comes without risk. Index ETFs don't always track the underlying asset perfectly and may vary as much as a percentage point at any given time. Investors should consider asset fees, liquidity, and tracking error among standard investing basics before making an investment.

RELATED TERMS
  1. ETF of ETFs

    An ETF of ETFs is an exchange-traded fund (ETF) that tracks other ...
  2. Double Gold ETF

    A double gold ETF is designed to respond to rises and falls of ...
  3. Leveraged ETF

    A leveraged exchange-traded fund (ETF) is an ETF that uses financial ...
  4. Oil Services Industry ETF

    Oil Services Industry ETF refers to an exchange-traded fund (ETF) ...
  5. Commodity ETF

    A commodity ETF is an exchange-traded fund that invests in physical ...
  6. Japan ETFs

    A type of exchange-traded fund that invests the majority of its ...
Related Articles
  1. Investing

    4 Ways to Evaluate ETFs Before Buying

    Learn four areas in which to evaluate an ETF investment to be sure that the investor has a clear understanding of the security being purchased.
  2. Investing

    Mutual Fund Vs ETF: Which is Right For You?

    Want to invest but don't understand the difference between investment products? Here we explain ETFs vs. Mutual Funds and which is right for you.
  3. Investing

    How To Avoid Expensive ETFs

    Discover four tips for avoiding expensive ETFs. Learn why expense ratios should be low and how to prevent your investment from costing you come tax time.
  4. Tech

    How To Pick The Best ETF

    Of the hundreds of exchange-traded funds on the market, some are bound to fail. Learn how to pick the best of the bunch.
  5. Investing

    A Look At the Growth Of the ETF Industry

    Explore the phenomenal growth rate of the ETF industry, and learn some of the principal reasons why ETFs are projected to continue to grow at a rapid pace.
  6. Investing

    4 Things to Know Before Choosing an ETF

    ETFs are a low-cost way to get exposure to different markets. But they're not all the same. Investors should research the following key information regarding the ETF before buying it.
  7. Investing

    When Is the Right Time to Change From Mutual Funds to ETFs

    Find out how to determine when it's the right time for you to switch from mutual funds to ETFs, including the benefits of ETFs and who they are best for.
  8. Investing

    Guide To ETF Providers

    The exact number of ETFs on the market at any one time ebbs and flows, these twelve ETF providers offer hundreds of popular ETFs.
  9. Investing

    ETF Tracking Errors: Is Your Fund Falling Short?

    Find out the size and causes of ETF tracking errors and which funds are at risk.
RELATED FAQS
  1. Who's in charge of managing exchange-traded funds?

    An exchange-traded fund (ETF) is a security that tracks an index but has the flexibility of trading like a stock. Just like ... Read Answer >>
  2. Should I invest in ETFs or index funds?

    Learn advantages to investing in exchange-traded funds, or ETFs, and index funds, and decide whether to include them in your ... Read Answer >>
Hot Definitions
  1. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  2. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  3. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  4. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  5. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  6. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
Trading Center