More than just because all your friends are doing it, you’re looking at investing and thinking about all the possibilities to stretch your dollar for many reasons. It doesn’t help that in this big, bad world, a lot of jargons are thrown in your face and it’ll take time and effort to find out where you should be investing your money wisely.
Part of investing and managing a portfolio is putting money into different kinds of financial products. This is where funds can really help individual investors with limited funds. Investing in a fund is not as complicated as it may seem.
Why Mutual Funds or Exchange Traded Funds at all?
The biggest benefit of putting your money in any kind of investment fund is that a lot of the hassle and the cost is taken out of investing for you. If you have a limited amount of money to invest you can buy a share in a fund and get exposure to a wide range of investments – without having to buy each individual asset yourself. This can cost a lot in transaction fees and also mean you have to spend a lot of time watching each individual investment. You do not have to risk putting your money into only one asset – such as one stock or one bond.
Also when you invest in a fund, the people managing the fund have more experience and expertise than you and I, and can help generate a better return for all investors as part of managing the fund. This can also help minimise the risks to the money you have invested. Overall, typically the risks are lower, costs lower and your likelihood of earning a better return is improved by investing in a fund.
Mutual Funds or Exchange Traded Funds – what’s the difference?
However, investors, both beginners and the more experienced are often confused about the differences between an exchange traded fund (ETF) and a mutual fund. You may have heard of these terms before. If not, do not worry – they are not as complex and scary as they seem.
Both products are pooled investments. For example, if you a share of an S&P 500 index mutual fund or an S&P 500 ETF, and will get a small slice of the performance of the same 500 companies from the S&P 500 index. Even though both an ETF and a mutual fund give you this similar outcome there are some key differences between the two.
How Mutual Funds or Exchange Traded Funds Work
Firstly with an ETF you are normally getting the performance of a particular index for your money. This will be decided and set in place when the ETF is originally set up and will not diverge from tracking that index.
However many mutual funds, the majority in fact, will not just adhere to tracking the index. For example the mutual fund may be set up to track the S&P 500 initially but as the managers who run the fund watch the markets and look for different opportunities they may change the composition of the fund to generate better returns for investors. They may change the proportions of the different stocks in the fund for example and not just simply track the proportions of the S&P 500.
This ability to diverge from the index is called “active management” – it means the managers of the mutual fund will actively look for ways to make improved returns on investor money. They will apply their knowledge, skills and experience to achieve this.
Things to look out for
Because of this extra expertise involved, mutual funds are often more expensive than ETFs – another key difference between the two investment choices. However be careful to keep an eye on the fees involved – the overall costs can vary depending on the commissions you pay when buying or selling.
Also in general it is harder to get in and out of your share in a mutual fund – you have to wait for the end of the trading day price to see where you can buy and sell. On the other hand, with an ETF you can buy and sell a share in the fund at any time in the trading day.
Another important difference is that mutual funds are not as transparent. What this means is at any given moment in time, you cannot just check what is being held in the fund -mutual funds will typically report their holdings quarterly. However, with ETFs you can always know and see what stocks, bonds etc. the fund is holding.
Where to go from here?
Overall you have to select the investment that is best for your needs. The lower fees from an ETF can seem appealing but you might get a better return if you invest with a mutual fund.
Make sure that you do some research before putting your money into either – take a look at the sectors and investments the funds cover and also the track record of the fund. This can help you to gauge how risky the fund is and what kind of return you can expect to achieve from your investment and over what time period.
Also really important when investing in any type of investment fund is to find out all the costs involved before putting your money. So many people make the mistake of not knowing the costs before investing and getting shocked or surprised later when they see a cost or fee on their statement. Avoid this by getting to know your funds costs in advance. With some care and attention your money will generate great returns in either an ETF or mutual fund.
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