ETF vs index fund: the fee is not what decides.

01What they are, in two lines

An index fund is a mutual fund that tracks an index. You buy and sell at net asset value, once a day, directly with the fund company.

An ETF is a fund that also trades on an exchange. You buy and sell it like a share, through the session, with a bid-ask spread and whatever your broker charges.

Inside, both hold the same portfolio. If they track the S&P 500, both own the same companies at the same weights.

02The difference almost nobody puts first

In a taxable account, the decisive difference is who pays for other people's selling.

When investors leave a mutual fund, the fund may have to sell holdings to pay them, which realises capital gains. Those gains are distributed to everyone still in the fund — including you, who did nothing. You get a tax bill for a transaction you did not make.

ETFs largely avoid this through in-kind creation and redemption: shares are exchanged for baskets of securities rather than cash, so the fund rarely has to sell. The practical result is that broad-market ETFs distribute capital gains far less often than comparable index funds.

03The differences that exist and rarely decide

• Expense ratio. ETFs are often marginally cheaper, but we are talking about fractions. Across the 332 funds we measured, index trackers had a median ongoing charge of 0.16% a year. The gap with an equivalent ETF rarely decides anything.
• Intraday trading. An ETF buys at 11:14; a fund buys at the closing NAV. If you are investing for ten years, whether your entry price was set in the morning or the afternoon is noise.
• Cost of transacting. Here the ETF loses: brokerage and the bid-ask spread on every purchase. On small, frequent contributions that eats the fee advantage comfortably.
• Automation. Mutual funds accept automatic recurring contributions almost everywhere. With ETFs it depends on the broker, and plenty still do not support fractional or scheduled buys.

04What to check in both, and almost nobody does

Before comparing product against product, three things apply to both and decide more than the label:

• Accumulating or distributing. An accumulating share class reinvests dividends inside the fund; a distributing one pays them out, and you are taxed on them each year. For long-term compounding in a taxable account, accumulating avoids an annual leak — where it is available to you.
• Tracking difference. How far the product drifts from the index it claims to replicate, which can exceed the expense ratio itself. It is published and comparable.
• Which index exactly. «MSCI World» and «MSCI World SRI» are not the same index, and two products with near-identical names can hold different portfolios.

05The short answer

• ETF in a taxable account, especially for broad-market exposure held for years, where avoiding unwanted capital gains distributions compounds.
• Index fund in a tax-sheltered account, or wherever automatic recurring contributions matter more than the last basis point — the tax advantage of the ETF is worth nothing inside an IRA.
• Both is a perfectly valid answer, and more common than it sounds.

What is not an answer is choosing on the expense ratio alone. It is the most quoted criterion and almost never the one that moves the most money.