Like many financial advisors, EsqWealth encourages clients to always consider diversification when determining how to invest assets. Diversification helps minimize the risk that your investments will lose value all at once, and you broaden your opportunity for gains. Investors often look to the world of funds to achieve that diversification. Mutual funds, index funds, or exchange-traded funds (ETFs) can offer a wide-ranging exposure to an asset class, a region, or a specific market, without requiring you to purchase several individual securities. These funds might hold diverse baskets of securities, including stocks, bonds, and other assets from real estate to derivatives.
A basic understanding of how each type of fund works should be the starting point in determining whether you should consider these funds in addition to or in lieu of owning individual shares of a company. EsqWealth can help you determine which approach is best for you given your risk tolerance and personal goals. Below is a brief description of the basics.
A mutual fund pools money from many investors and uses it to invest in a variety of securities. Mutual fund shares represent partial ownership of the fund and entitle investors to the income generated by that portion. These funds tend to have minimum investment amounts between $500 and $5,000.
Mutual funds are usually actively managed. Experienced professionals select and monitor the securities held in the fund, with the aim of maximizing return while ensuring their selections meet the goals laid out in the mutual fund’s prospectus. Active management can make mutual funds a relatively expensive choice compared to other fund options. Compare fund expenses by looking at a fund’s expense ratio, which compares total fund costs to total fund assets. The lower this percentage, the cheaper the fund is to own. On the other hand, higher expenses can eat into your long-term returns.
Unlike stocks, which trade throughout the day, mutual funds only trade once per day after the market closes. Prices are based on a fund’s current net asset value (NAV), calculated by adding the total value of the fund’s holdings and subtracting its liabilities.
In addition to stock and bond funds, money market and target-date funds (TDFs) are other common mutual fund options. Money market funds invest in short-term debt. They’re designed to provide higher returns than interest-bearing bank accounts, and are used by individuals and institutional investors to invest in shares of government bonds, corporate stock, bank debt, and more. TDFs are popular retirement investment vehicles. Individuals select a TDF with a particular a target date, such as the year they wish to retire, and the fund gradually shifts to a more conservative asset allocation as that date approaches.
ETFs differ from mutual funds largely in the way investors purchase them. They are traded on the stock market throughout the day just like stocks, making them a more liquid option than mutual funds. There are no minimum investment amounts, and some brokers even allow you to buy fractional shares.
ETFs are usually passively managed, built to track a broad market benchmark. Passive management doesn’t require daily human touch, which often makes them a cheaper option than mutual funds. That said, some actively managed ETFs do exist, often with the goal to outperform a benchmark. Investors will likely pay more for active funds.
What are index funds
An index fund can be a mutual fund or an ETF, but they are passively managed and built to track a market index, such as the S&P 500 or Russell 2000, for instance. Depending on the design of the index fund it may track all or a portion of the securities in a given index. As mentioned above, passively managed funds tend to be cheaper than active alternatives.
Contact EsqWealth today if you would like to discuss your short- and long-term investment goals. We can help guide you toward the investment tools that are right for you.