Friday, 13 September 2019

What Are Mutual Funds, Index Funds, And ETF?

I am going to be sharing what is the difference between mutual funds, index funds, and ETFs. For me, this was something that took a little bit of time for me to understand because it's not really that difficult to understand when somebody explains it to you. But it takes a while for you to figure it out if you are doing your own research. Let's dive in and talk about mutual funds, index funds, and ETFs. Because there is a lot of confusion around these items, they get interchanged when people are talking about them. I just want to give you a quick basic overview, I have some differences and similarities between these 3 investment types that you can do in the stock market 

Let's Get Started

Mutual Funds

There are two types of mutual funds

  1. Actively Managed Fund
  2. Index Funds: Which is not actively managed

When people are talking about investing in mutual funds, they are sometimes not clear on what they are talking about, whether it's an actively managed mutual fund or if it's an index fund.

Let's just clarify

Actively Managed Funds

An actively managed fund is when it's actively being managed. Someone is in charge of this fund and they are deciding what stocks to put in and if those stocks start dipping down, then they decide to take out some of those, and put in some different ones. They are constantly changing that mutual fund, and it's usually more expensive to invest in actively managed funds. They have a higher expense ratio and both of these types of funds have expense ratios. When you are picking your investments, you want to make sure that you are paying the lowest amount possible in fees. You are going to have an expense ratio with actively manages funds and index funds. The expense ratio for actively managed funds is higher than an index fund because they are actively managed. Someone is deciding what stocks to pull in and when to replace them.

Index Funds

With an index fund, that is tracking something else. It's not actively managed, it's just following an index. For example, there is a vanguard total stock market index fund, and that fund follows the total stock market. It makes sense because it's an index fund that is tracking the total stock market. When you are looking to invest, I actually like investing in index funds because they have that lower expense ratio, the higher the expense ratio, the more money it's going to be taken out of your investments and you won't be able to grow that money as much overtime. If you have a lower expense ratio like with an index fund, you are actually making more money because essentially the actively managed funds don't have a higher return than an index fund. That is why I like index funds, they have a lower expense ratio and they still get a good return for you.

When you are talking about mutual funds, and someone is telling you about them, make sure and ask is it actively managed the mutual fund? Or is it an index fund that you are talking about. Is it tracking something else?

Hopefully, that helps a little bit and the index fund is just tracking something else, so it's going to cost less to invest in that because there is no someone actively managing that fund. Like with an actively managed fund.

Let's Talk About ETFs

ETF is (Exchange-traded funds) and they are a little different from a mutual fund, but they act like an index fund because they are still tracking something else. they are not actively managed, it is another type of fund but it is an exchange-traded fund. There is total stock market ETF that is tracking the total US stock market and it's really easy to invest in ETFs because they don't have a minimum amount that you have to invest, it's just the price of the ETF.

Let me explain what I mean.

When you are purchasing ETFs, it's going to be the price of the ETF itself and with an index fund, they set a minimum amount that you have to invest in order to invest in the fund and the example that uses, the total index fund, has a minimum amount of $3,000 to invest. Not all index funds are that high and some are actually higher than this, but some of them could be a $1,000, $2,000, or even up to $10,000, depending on your fund. But you want to keep that in mind when you are deciding what you want to invest in and if you don't quite have that $3,000, maybe you want to start with the ETF and invest in the ETF. ETFs price at about $143, that is quite a significant difference, $143 compared to the $3,000. ETFs are easier to get started and if you don't have quite as much money to begin investing, then you can start investing in ETFs.

ETFs act as stock, in the fact that you can purchase the ETF throughout the entire stock trading day hours, and you can choose to purchase the ETF, let's say at noon or for whatever price it's showing currently on the ETF. If it's showing $144 at noon you can go ahead and purchase it for $144. With an index fund, you have to wait until the close of the trading hours of that day, and whatever the price is for that index fund, is what you will pay. Even if you place your order at the beginning of the day, you are actually purchasing it at the end of the day. It's doesn't act like a stock

With an ETF, you also have an expense ratio, you want to make sure that the expense ratio is low on your ETF as well as if you are going to invest in an index fund, and the ETF ratio is exactly same as the index fund 0.04%. It's a super low ratio.

Commission Fees

When you are purchasing ETFs, there will be a commission fee or a commission charge. Most of the time depends on who you are investing with, for example, if you were investing with Vanguard they charge a $7 commission fee. Since ETF is similar to a stock, you are going to be paying that commission fee each time you buy and sell your ETF. If you are investing in index fund there is no commission fee and there is no one-time fee to invest in an index fund, but there is with an ETF.

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