Exchange Traded Funds (ETF) vs Index Funds vs Mutual Funds
- IWT
- Oct 27, 2022
- 3 min read
We understand at IDEASWORTHTRADING that making sense of mutual funds, index funds and exchange traded funds (ETF) an be a little tricky. Below are a few posts and points about the 3 funds (pros and cons) that we hope you find helpful. It is really a broad overview and each of the fund types have additional details that go beyond what you may find here.
We don't claim to be experts. Actually we are just like you in the fact that we are learning as we go along. So we hope you find some of the information that is shared helpful in your journey to be become financially aware.
An ETF is short for exchange-traded fund. First introduced in 1993, this type of investment has grown steadily over the years and now comprises $10 trillion+ in investor assets globally.1 In the U.S., the ETF market is $5+ trillion, roughly one-quarter the size of the U.S. mutual fund market.2
ETFs are popular because they combine features of mutual funds and stocks, often at a low cost compared to similar mutual funds. Like a mutual fund, an ETF is a bundle of many securities that can be bought in one purchase. This usually provides the investor with the benefit of diversification, although the degree of diversification varies depending on how narrow or diverse its holdings are.
Like a stock, they are traded all day on an exchange and can be bought anytime during the day for their trading price at that moment. This distinguishes them from mutual funds, which can only be bought after the trading day ends, when their price for the day—the Net Asset Value, or NAV—is calculated. (You can place an order for a mutual fund during the day, but it won’t be executed until the end of trading.)
While many ETFs are designed to mimic an index, such as the S&P 500, they should not be confused with Index Funds. Index Funds are mutual funds that track an Index.
An index fund is a type of mutual fund or exchange-traded fund (ETF) that holds all (or a representative sample) of the securities in a specific index, with the goal of matching the performance of that benchmark as closely as possible. The S&P 500 is perhaps the most well-known index, but there are indexes—and index funds—for nearly every market and investment strategy you can think of. You can buy index funds through your brokerage account or directly from an index-fund provider, such as Fidelity.
When you buy an index fund, you get a diversified selection of securities in one easy, low-cost investment. Some index funds provide exposure to thousands of securities in a single fund, which helps lower your overall risk through broad diversification. By investing in several index funds tracking different indexes you can built a portfolio that matches your desired asset allocation. For example, you might put 60% of your money in stock index funds and 40% in bond index funds.
What is an Mutual Fund?
A mutual fund is a professionally managed portfolio of stocks, bonds and/or other income vehicles devoted to a specific investment strategy or asset class. When investors buy shares in the fund, the mutual fund company pools that money to make investments on their behalf. A share represents a portion of the fund's holdings.
Mutual Funds
Pros:
Mutual Funds (Pool or basket of stocks)
Convenience – You don’t have to buy each individual stocks and pay a commission on each purchase.
Diversification – Basket of different stocks
Fund Manager – A professional money manager picks the stocks. They will add or remove stocks as needed to the fund
Cons:
High Fees – It is managed by a financial professional which is “Actively Managed”
Cost – Even if your account doesn’t make money you still have to pay the management fees.
Example: (Your account $10,000 * 2% fees = $200 annual) Check out this article from Charles Schwab for some ideas: Click Here
Big Idea: A good introduction to investing can be an Index Fund. Since it doesn't trade like a stock you won't be tempted to buy and sell often. With automatic purchasing you will buy more shares without paying additional fees. Both ETFs and Index Funds fees are lower than Mutual Funds which might help save more money down the road.
Until Next Time, Keep Sharing
IDEASWORTHTRADING
Comments