Mutual Funds and ETFs

What is a Mutual Fund?

A mutual fund in an investment vehicle made up of a pool of capital from many investors.  The fund’s purpose is to invest this pool of money  in different types of securities such as stocks and bonds and is usually overseen by a fund manager and/or team.  They invest the fund’s capital actively with the purpose of generating capital gains and income for the fund’s investors.  The fund’s portfolio is constructed  in a way that matches the investment objectives that are outlined in its prospectus.  A fund can be invested in multiple shares of different securities, such as stocks or bonds,  and can have holdings that cross different asset classes.

What is an Index Fund?

An index fund is a mutual fund that invests in holdings that mirror or track a certain market index.  There are many different kinds of indices.  One of the most well-known is the S&P 500 Index.  Index funds are passively managed.  There is no attempt to “beat the market.”  Rather, the managers of an index fund try to replicate as closely as possible the performance of its benchmark index.  Because of this, index funds tend to have lower costs and portfolio turnover compared with their actively managed counterparts.

What is an ETF?

An ETF, or Exchange-Traded Fund, is a fund of securities such as stocks, bonds, or commodities that can be traded on an exchange throughout the day.  In this manner, they are similar to stocks.  Most ETFs track an index.

What is the Difference Between an ETF and a Mutual Fund?

The main difference between an ETF and a Mutual/Index Fund is that an ETF can be traded throughout the day while a mutual fund is priced once daily, usually at the close of the trading day.  Like index funds, ETF’s tend to have lower fees and portfolio turnover.

A Word On Fees

I am a big proponent of minimizing fees and investment costs.  As I detailed in a previous post, they can have a drag on your investment returns over time.  Since index funds and ETFs tend to have low fees, I tend to invest in those rather than actively managed funds.  One thing to keep in mind is that trading ETFs can incur brokerage fees.  These can also eat into your returns.

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