Index Funds Mutual Funds ETFs Defined

Post on: 9 Август, 2015 No Comment

Index Funds Mutual Funds ETFs Defined

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Some years ago I was introduced to some literary techniques such as pleonasm, paronomasia, epizeuxis, and hendiadys.  Then, of course, there is the zeugma and aposiopesis.

Sometimes people can be speaking English, but it has absolutely no meaning to us.

Unfortunately, the same is often true for some people when personal finance writers use ‘elite’ language.  They talk about ETFs, Mutual Funds, and Index Funds .  Unfortunately, those words don’t always mean something to everyone.

When you want to learn how to start investing it is important that you learn about these different ways to purchase stocks and bonds.  In this post, I’ll speak plain English in an effort to help you be able to understand the difference between an ETF, mutual fund, and index fund.

As you read the list below, just remember ETFs, Mutual Funds, and Index funds all own multiple of stocks (or bonds) from different companies.  In this post, we’ll talk only about stock ownership. not bonds.

What Are Index Funds?

Index Funds are groups of stocks that are purchased according to a certain index.  For example, there is the S&P 500.  This index tracks the performance of 500 stocks of large and well-established companies.

When a person buys an Index Fund, they are buying a fund that owns stocks of those same 500 companies tracked by the S&P 500.  How the index performs will mirror how your index fund performs.  Therefore, when the S&P 500 goes up 5%, you can expect your investments have gone up 5% (minus fees).

Index Funds are often called passive funds.  Those who invest in index funds have no intentions on trying to beat the market.  Instead, they simply want to have returns in line with the overall market performance.

Index fund investors realize that in an attempt to beat the market, you also run the risk of falling behind average market returns.

Deciding on an index fund is often quite easy.  When evaluating your options, the index you wish to track is the most important choice.  It is also the choice that will have the biggest impact on your returns.  Once you have decided on the right index, you need to consider the fees.  There will be fees for the administration of the fund and also some buying and selling fees associated with the index fund.

What is a Mutual Fund?

A Mutual Fund is a group of stocks owned collectively by the mutual fund investors .

If a certain mutual fund owns shares in 100 stocks and you buy a share of the mutual fund, you have mutually (along with the other shareholders) purchased a part of those 100 stocks.

The biggest difference between an index fund and a mutual fund is that mutual funds are actively managed.  In other words, there is a person (or group of people) who are studying and analyzing trends and charts to pick the right stocks that she thinks will beat the market.

Thus, is it an active investing strategy compared to the passive strategy of index fund investing.  The goal is to beat the market, not just match the market.

You must remember that every fund manager has his or her own style, temperament, and strategy.  This is why there are extra steps and more research involved in investing in a mutual fund.  One manager might buy only at risk small companies which have a huge potential for both loss and gains.  Another manager might only buy stocks from large, established companies.

Thus, with a mutual fund, once you have decided the type of fund you want you then need to find a manager who suits your investing preference.  You would get all of this information from the prospectus.  Be sure you are also aware of the mutual fund fee structure .

Are you new to mutual funds?  Here are things everyone should know about investing in mutual funds .

What is an ETF?

ETF stands for Exchange Traded Funds.

It is important to note that it is possible to buy actively managed ETFs (like mutual funds) and passive ETFs (like index funds).

So how are ETFs different?

Basically, ETFs are traded all throughout the day.  With a mutual fund, you can only buy at the price at the close of business day.  ETFs can be sold and purchased throughout the day.

In addition, ETFs are easier to invest smaller quantities of money.  Many mutual funds and index funds have around a $2,500 investing minimum.  With an ETF, as long as you can pay the broker’s commissions and the cost of at least one share, you are in the game.

Is it better to invest in an ETF, Mutual Fund, or Index Fund?

This is the age old debate that has raged for decades, and I don’t suppose I’ll settle it in one moment.  However, here are some guidelines to help lead you in the right direction:

  1. Do you like to do a lot of investment research and analysis?  The stronger you answer no, the better an index fund becomes.
  2. Do you need a fund that, for tax reasons, has less buying and selling (short term gains)?  The stronger the yes, the better an index fund becomes.
  3. Do you have a lot of money to start investing?  The less money you have, the more you should look at ETFs.  This is especially true if you use something like Charles Schwab that offers fee free ETFs.
  4. Do you like a more aggressive investing strategy?  The stronger the yes answer, the more you should look at mutual funds.
  5. Do you know a lot about investing?  The less you know about investing. the safer you will be using index funds until you have a chance to learn how to start investing.
  6. What investing strategy do you use?  Do you buy funds once a year, do you dollar cost average, or do you used a be averaging investment strategy ?  The more frequently you trade the more you should look at ETFs as they typically have the lowest trading fees.  Check with your broker for the exact fees.

Photo by Katrina.Tuliao.

What investing advice or suggestions would you give to someone considering ETFs, mutual funds, or index funds?

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