Index fund vs. Mutual Funds Vs. ETFs
preface
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Introduction
Mutual fund
index fund
etf fund
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Introduction-:
If you want to invest in a diversified way, then you will come across 3 different
fund types: Mutual Funds, Index Funds and ETFs. And it’s easy for beginners to get
confused. That’s why in this article, we will be looking at the 3 different fund
types, see what their differences are, explain them in a super simple way and look at
which one you should invest in - so let’s go!
So if you are new here, bookmark our website Let’s start with the first one
MUTUAL FUND-:
ABOUT-:
A mutual fund is an investment company that pools money from many investors to
buy assets such as stocks. Imagine a group of people with 100 dollars each.
They now put in that 100 dollar bill in a basket. These people just mutually funded
that basket.
HISTORY/WORKING PROCESS
A mutual fund works in a similar way. The first mutual fund was launched in 1924
and it became mainstream in the 1980's. A traditional mutual fund is an actively
managed fund that is run by a fund manager. It means that investors give money to
a fund manager who is picking stocks or other assets on behalf of the investors.
And the goal of the fund manager is to get a return that is higher than the
average market. They could also actively shift a portfolio towards more defensive
assets when there is a market downturn. They would then sell risky investments like
stocks and add more conservative investments like bonds. Actively managed funds
are more expensive than
ETFs or index funds because the investors need to pay the salaries of
the fund managers and their research team. The expense ratio that investors
need to pay for a mutual fund is around 1% per year on the money that
you invested.
PROFIT-:
if you invested 1,000 dollars, your mutual fund fee would be 10 dollars per year.
Mutual funds can have a high minimum investment amount. This minimum
investment amount has gone down in recent years because of the high
competition from the ETF market, but with some mutual funds you still need
to invest a minimum amount of 5,000 dollars.You can invest in a mutual fund
directly through investment companies like Vanguard or Fidelity
instead of buying them on a stock exchange. And another thing about
mutual funds is that you can only buy them after the market closes at 4PM.
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If you put in an order to buy 1 share in a mutual fund in the morning,
then the transaction will only go through after the market closes and at a price at
market close.
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If you put in a buying or selling order after market close, then the transaction
will be pushed into the next day at market close. So most mutual funds are actively
managed funds. But that’s not the only type of mutual fund. And that brings us to
the second fund type:
Passively managed mutual funds- also known as index funds
INDEX FUND-:
ABOUT
An index fund is a type of mutual fund that tracks an index like the S&P 500.
So instead of trying to pick stocks that could outperform the market, an index
fund simply buys all the shares of an index. So instead of trying to beat the market,
an index fund is just trying to track the market. The first index fund was the Vanguard 500
HISTORY-:
Index fund which was launched in 1976 by Jack Bogle, the founder of
Vanguard. Owning all the stocks in an index like the S&P 500
will give you the average return of the market. And historically, this was the most
successful strategy over a longer period. In fact, only 10% of actively managed
funds could beat the S&P 500 as a benchmark
over a time
if you don’t wanna take a 90% risk of underperforming the market, then
a passive managed fund is the way to go.
Index funds come with another advantage. Since they only track an index,
there isn’t much active management going on here. So you don’t need to pay for
expensive fund
managers and their research teams to find "good stocks".
The average expense ratio for index funds is 0.2% - so much lower than
the 1% of actively managed mutual funds. Some index funds still have a minimum investment
amount of up to 2,000 dollars but more and more investment companies are reducing this amount.
Index funds are also bought directly from investment companies like Vanguard
or Fidelity and not on a stock exchange. And same as mutual funds, you can only
buy them once a day at market close at 4PM. So when you submit a buying or selling order, you won’t know the price until your order gets executed.
ETF FUND-:
Now the third fund type is an ETF. ETF stands for exchange-traded fund
. It’s a fund that is traded on a stock exchange. The first ETF, the S&P 500
Trust ETF, was launched in 1993 by State Street.
An ETF is a bit different from mutual and index funds. The first 2 fund types
were either
active - like the traditional mutual fund
passive - like the index fund.
An ETF can be both: Active and passive. It depends on the ETF that you pick.
If the objective of an ETF is to simply track an index like the S&P 500, then it’s
a passive ETF.
And that’s the case for most ETFs. But an ETF can also be actively managed
where a fund manager picks stocks. But that’s the exception - only 2% of the total
ETF capital is actively managed.
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Compared to mutual and index funds, ETFs are more liquid, so they can be
converted into cash easily, because they are traded just like stocks. That’s the case
for larger ETFs where there are a lot of buyers and sellers
that trade the ETF frequently. But if you invest in an ETF that has a small fund
size and that not a lot of people trade then you could end up selling an ETF below
market price. That’s why it’s so important to check the fund size of an ETF before
you invest.
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If you wanna know 5 more things to look out for before investing in ETFs, then check out the article
Because ETFs are bought and sold on an exchange, you will pay a commission to
your broker each time you make a trade. But the good news is that more and
more brokers and trading apps are offering commission-free trading.
Then you also have the expense ratio which is 0.2% on average for
passive ETFs. You can also find ETFs with an expense ratio of 0.02% - no
problem. Actively managed ETFs have a higher expense ratio because you will
have to pay for the fund manager again.With ETFs, you don’t have a minimum
initial investment amount.
If you have 50 dollars, you can start investing that into an ETF that tracks the S&P 500
which fund type is best for you?
There is not the one best fund strategy. But there are 5 things to consider.
Number 1
that is diversification.Whatever fund you go for, make sure that you
are diversified in your investments - not just when it comes to industries and
countries but also across asset classes. Because stocks are just one
out of many asset classes.
Number 2
this is consistency. No matter what option you choose, it’s important to stay
disciplined.Keep investing a fixed amount on a regular basis. Stay disciplined and
don’t sell in a down market but rather keep investing.
Number 3
thing to consider is that it’s hard to beat the market.Passive investing has been
the more successful strategy in the long run.That’s why even the best investors of
our lifetime like Warren Buffett tell investors to use passive,
diversified, low-cost index funds or ETFs. Buffett once said in an interview that
“The trick is not to pick the right company.
the S&P 500 and do it consistently.” And that’s one of the many reasons
why more and more money is flowing out of actively managed mutual funds into
passive index funds and ETF.
Number 4
this is downside protection. With an index fund or a passive ETF
you are at the mercy of the market. If the market crashes, then your investments
will crash in the same way.
One advantage that actively managed funds have is that they can use hedging
strategies to protect your investments from market crashes. And the last thing to
consider is to invest long-term.
Give your assets enough time to grow and be patient during times
where the market doesn’t move up.
There have been a few times where the stock market didn’t go up for more than a
decade like in the 70s and 2000s. But if you hold stocks long enough, then you
can expect an annual return rate of 8% which is the S&P 500 average for the
last 100 years
adjusted for inflation and including dividends.
conclusion-:
In today's topic, we talked about how we can easily invest in index funds or mutual funds or etfs, as well as if you want to get information related to finance, you can bookmark in our website.
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