For better or worse, you have nearly unlimited options when it comes to investments and investment strategies.
Personally, I like to take a simple approach and to invest in funds, which are investment vehicles that group together stocks or bonds into one bundled investment. For example, if I wanted to buy every company in the S&P 500, I could buy one S&P 500 fund instead of buying all 500 stocks individually.
When it comes to investing in funds, of course, there are few options you have as well. Below we’ll break down the basics to give you enough of an understanding so that you can get started today. You’ll learn the differences between mutual funds, index funds, and exchange-traded funds (ETFs).
And remember, you don’t have to be an expert to start investing on your own! You just have to know enough to get started the right way.
Mutual funds are diversified investment vehicles made up of multiple, smaller investments. Typically, they are actively managed by a professional fund manager.
The goal with most mutual funds is to “beat the market.”
You are paying a fund manager to make investments on your behalf within this fund, with the hope that they will make smart moves and make back their costs and then some. Though this does not always happen, and in fact, it usually doesn’t.
Mutual Fund Pros:
- Diversification: You get access to a lot of different investments quickly and easily
- Potentially Beat the Market: There is a possibility to beat the market, albeit unlikely
Mutual Fund Cons:
- Cost: High expenses and fees
- Usually, Underperform the Market: More often than not, mutual funds underperform the market (especially when you take into account the fees you have to pay)
Examples of Mutual Funds:
- SWDSX: Schwab Dividend Equity Fund
- VWUSX: Vanguard U.S. Growth Fund Investor Shares
- FLCEX: Fidelity Large Cap Core Enhanced Index Fund
Index funds are also diversified investment vehicles made up of multiple, smaller investments. However, unlike mutual funds, they are passively managed and match a broader index, like the S&P 500.
Technically, index funds are a type of mutual fund. Except, instead of being actively managed by a fund manager, they are set up to match a pre-established index. This index could be a stock index, like the S&P 500 mentioned above, or a bond or real estate index.
Since there is zero active management within index funds, they usually entail much lower fees and expenses compared to traditional mutual funds.
Index Fund Pros:
- Simplicity: Matches a broad index that is easy to understand and track
- Cost: Low expenses and fees
Index Fund Cons:
- Flexibility: Similar to other fund options, you have less control over what you invest in
Examples of Index Funds:
- SWPPX: Schwab S&P 500 Index Fund
- VFIAX: Vanguard 500 Index Fund Admiral Shares
- FZROX: Fidelity ZEROSM Total Market Index Fund
Exchange-Traded Funds (ETFs)
Last but certainly not least, we have the option of Exchange-Traded Funds (ETFs). ETFs are also diversified investment vehicles made up of multiple, smaller investments. Though, they operate more like stocks compared to their mutual and index fund counterparts and can be bought and sold throughout the trading day.
There is also a wider variety of ETFs, ranging from ETFs that match an index (like index funds) to ETFs that are leveraged and employ more advanced trading techniques.
- Cost: Low expenses and fees
- Trade Flexibility: Can be traded throughout the day (a minor perk for long term investors, but an important one for day traders)
- The Spread: ETFs have a bid-ask spread, just like a stock, which is an added fee for investors
- Cost: Not all ETFs are low cost, as some act more like mutual funds and employ more complicated investment strategies
Examples of ETFs:
- SCHB: Schwab Broad Market ETF
- BND: Total Bond Market ETF
- FBCG: Fidelity® Blue Chip Growth ETF
Quick investment comparison: Mutual Funds vs Index Funds vs ETFs
|Mutual Funds||Index Funds||ETFs|
|Fees and Costs||Medium to High||Low to Medium||Low to Medium|
|Investments||Stocks, bonds, and more||Stocks, bonds, and more||Stocks, bonds, and more|
|When Traded||End of day||End of day||Throughout the day|
Why I prefer all three to buying individual stocks
I’ve been investing since I was old enough to invest on my own. To start out, I exclusively invested in stocks.
I did this for two reasons:
- I thought I could beat the market myself by picking “winning” stocks
- I didn’t really know any of any other options at the time
Back when I first started, I invested in three stocks, and the results were so-so: one did really well while the other two flopped.
After a few years of holding these stocks, and underperforming the market, I bought my first Vanguard fund that automatically got me invested in hundreds of stocks instead of just the three. I quickly saw the benefit of investing in funds and attaining broader diversification.
Ever since then, I’ve been investing in stock, bond, and REIT funds to diversify my investments. I’ve pretty much steered clear of taking the risk of investing in individual stocks.
The winners: Index Funds and ETFs
When it comes to funds, I prefer index funds and ETFs over mutual funds.
This is for one main reason: cost.
When investing in an index fund or ETF that matches a broad index, you can find some with expense ratios of 0.10% or lower. On the flip side, actively managed mutual funds can easily charge up to 0.50% or higher.
When investing $10,000, that’s a difference of $40 per year. While that might not seem like a lot, as you add more money to your investments and see the funds compound over time, it can add up to thousands of dollars in unnecessary costs.
Not to mention, when investing in mutual funds, you run the risk of underperforming the market. Of course, you could do better, but it’s a gamble.
I prefer to take the certainty of matching the market for a lower cost.
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