When it comes too investing, you really need to understand the basics. I find most information online explaining the difference between Mutual Funds VS Index Funds Vs ETFs extremely confusing. Which is why I wanted to write an article for you to help you better understand these terms and identify which avenue is best for you and your portfolio.
A mutual fund was created as a way for a group of people to pull their money together and invest as a group in multiple different stocks. Yes you invest individually, but the group is investing in everything together. Think of it like you have 5 friends and all 5 friends buy and sell the same stocks at the same time. However, the difference is these mutual funds have millions of people buying and selling at the same time and billions of dollars under management.
A mutual fund is required to have a minimum of 90 stocks in its fund. In short, by owning a mutual fund you are owning a bunch of different stocks, but you only have to buy one asset. This allows you to get instant diversification. By having a diversified portfolio you are reducing the risk because you are invested in multiple stocks as opposed to just one.
The next important thing to note about a mutual fund is that it is managed by a professional and has to be purchased in. These funds are typically known as actively managed since a professional actively manages their holdings; typically comes with a hefty fee. I’ve written an entire article about the hidden costs of a mutual fund that I highly recommend reading before even considering investing in a mutual fund.
With a mutual fund you can’t short the market, it’s only for long term positions.
What is an Index Fund?
In 1975 Jack Bogle created the first index fund. For all intents and purposes the index fund was a game changer. An index fund follows a specific index, such as the S&P 500. Before you invest in an index fund it will state which specific index that fund is following.
An Index fund must follow a fixed formula, which eliminates the need for a professional to manage the fund. By not having a professional manage the fund you are able to eliminate a ton of additional fees. There are still fees associated with an index fund but they are substantially lower than a mutual fund fee. (Passively Managed)
It’s important to note that all index funds are mutual funds, but not all mutual funds are index funds.
What is an ETF (Exchange Traded Funds)
ETFs are very similar to a mutual fund. It’s in an investment fund that is traded like an individual stock. Unlike a mutual fund which has to be purchased and sold through the mutual fund holder, an ETF can be bought and sold on the open market / exchange.
Many times mutual fund have minimum that you have to invest in, while ETFs don’t require a minimum investment. In addition, ETFs can follow other industries such as oil, short selling, any commodities. Unless you are super specialized in these additional sector, I would steer clear from them.
Conclusion the Difference between Mutual funds VS Index Funds VS ETFS
In short a mutual fund is a group of stocks, bonds, and similar assets (t-bills, cash, etc), a mutual fund must be traded by a fund manager which means it comes with a hefty fee. If you invest in an index fund, you are literally tracking an index like an S&P 500.
Finally an ETF is also a group of assets, but is traded on the open stock market. An ETF can be bought and sold on most major trading platforms, plus, it doesn’t require a manager to buy and sell these ETFs. Keep in mind with ETFs there is a small fee as well. If you are looking for different platforms to start investing in, I highly recommend you check out this article and the entire investing section.
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