ETFs and indices
An index measures a market; an ETF lets you buy an image of it in one instrument. They are different things and often confused.
What an index is
An index is a number summarising the behaviour of a set of securities picked by clear rules (for example the largest in a country). You cannot buy it directly: it is a measure, not a product.
Indices differ in how components are weighted: by market capitalisation, equal weights, or other rules. That changes the result.
What an ETF is
An ETF is an exchange-traded fund that tries to replicate an index. It trades like a stock during the day. One purchase gives exposure to many securities.
What to check
Annual cost (TER): it reduces return every year. Replication: physical (holds the securities) or synthetic (through derivatives). Trading currency vs index currency: they can differ. Dividends distributed or accumulated. Fund size and liquidity.
An ETF tracks an index with small gaps (tracking difference) caused by costs and replication method.
In short
- Index = measure; ETF = instrument that tries to replicate it.
- The TER is a certain cost, return is not.
- Check replication, currency and dividend treatment.
- A sector or single-theme ETF can be poorly diversified.
Check your understanding
Can you buy an index like the S&P 500 directly?
Show the answer: No. It is a measure. You can buy an ETF or fund that replicates it.
Two ETFs track the same index; one costs 0.10% and the other 0.50% a year. What changes?
Show the answer: With the same replication, the second keeps 0.40 percentage points more every year: over the long run the gap accumulates.