Investing Basics: ETFs and Mutual Funds
When starting out investing, there are a bazillion ways to gain exposure to the market. For investors big and small, this typically comes down to deciding between investing money in stocks, ETFs, and/or Mutual Funds. While individual stock investing can be lucrative, it requires a higher risk tolerance and a more hands on approach when it comes to portfolio management. This is where the advent of ETFs (Exchange Traded Funds) and Mutual Funds comes in.
At a high level, both financial instruments share the following:
- Made of up of a collection of stocks, bond, commodities, etc.
- Track the performance of different indexes, sectors, commodities, or other assets
- Less risky than investing in individual stocks
- Can pay dividends
- Can be passively managed
- mimic the holdings of a particular index or benchmark
- No management team
- Can be actively managed
- managed by one or more managers
- trades are made much more frequent than passively managed funds
- tend to be higher risk (with a potentially higher reward)
- strive to outperform a specific index or sector
That said there are some key differences that are important to understand.
ETFs
- Can be bought and sold on stock exchanges throughout the trading day just like individual stocks
- ETF shares fluctuate in value during the trading day
- Typically are passively managed and carry lower over all fees when compared to actively managed mutual funds
- Lower minimum cost of entry
- The minimum cost to enter an ETF position is the costs of 1 share of an ETF
- Ex. 1 Share of XLE at the time of this post would cost 48.19 to enter
- Offer more of a tax advantages due to the way ETFs are created and how they are redeemed
Example ETFs
- SPY - Tracks the S&P 500 Index
- QQQ - Tracks the NASDAQ 100
- XLE - Tracks the Energy Sector
- ARKW, ARKG, ARKK, ARKX - Actively managed ETFs managed by ARK investments focusing on new industries and disruptive technologies
Mutual Funds
- Transactions to buy and sell occur between investors and the fund itself, not on stock exchanges. These transactions usually take one business day to complete.
- Mutual Fund Value, also know as Net Asset Value(NAV) is calculated once at the end of each trading day
- Typically are actively managed and come with higher overall management fees
- Higher minimum cost to entry on average
- Most retail mutual funds required a minimum inital investment ranging from $500 to $5000.
- Offer automatic investing on a recurring basis via certain brokers such a Charles Schwab and Fidelity
- Capital gains taxes can be passed on to share holders for transactions executed by fund managers
Example Mutual funds:
Bonus: Index Funds
Index Funds, are passively managed mutual funds that track indexes (similar to the SPY ETF mentioned above). Index funds come with much lower expense ratios and generally outperform most actively managed Mutual Funds over time.
Example Index Funds:
- SWPPX - Schwab S&P 500 Index Fund
- FNILX - A zero fee fund that tracks the Fidelity U.S. Large Cap Index (something similar to the S&P 500)
Takeaways
- When comparing both ETFs and mutual funds, prefer funds with lower expense ratios
- Consider dedicating at least part of your portfolio to index funds (depending on your financial goals)
- If you are in an employer sponsored 401k or similar retirement plan, review your current asset allocation and consider swapping out any funds with high expense rations for
Feel free to leave questions in the comments below or on twitter.
Happy Trading!
Photo by Adeolu Eletu on Unsplash