At Call to Leap, we believe that conservative investing is the best way to go because it minimizes your level of risk. Instead of trying to purchase stocks like AMC that may or may not make you money in the short term, we believe it’s best to invest in a reputable fund that builds your wealth over time.
In this article, we’ll compare Index Funds vs ETF vs Mutual Funds so you have an understanding of which fund is a better investment decision for your portfolio.
Index Funds vs ETFs vs Mutual Funds
Can you try to comprehend how many good businesses there are in the stock market?
What if I told you there’s a way for you to purchase all of the greatest performing stocks in the form of one investment instead of dozens of individual stocks?
As always, we got some good news for ya.
Today we’ll compare Index Funds vs ETFs vs Mutual Funds. The three different types of funds allow you to purchase multiple high-performing stocks in one investment.
We’ll go over what they are, how they work, reasons to invest in them.
What is an ETF?
ETF stands for “exchange-traded fund.”
An ETF is a basket of securities that can trade like a stock.
In English, an ETF is a type of fund that allows you to purchase many different investments in one bundle. ETFs are relatively new compared to the other two fund types and have become a favorite among investors because of how easy it is to trade them.
How do ETFs work?
As we stated, ETFs trade like stocks. This means you can buy and sell them on your brokerage app when the stock market is open. ETFs even have ticker symbols just like stocks.
ETFs usually focus on one type of security like a specific stock sector, index, or commodity like gold.
For example, Vanguard’s ETF, VOO mirrors the S&P 500 Index. (Not to be mistaken for index funds) You can think of a market index as a list that measures the performance of a certain niche of the stock market.
The S&P 500 measures the performance of the largest 500 companies in the United States. So, the ETF, VOO includes stocks that copy the index of the S&P 500.
The argument for ETFs
Low management fees: Depending on the fund, you may pay a management fee quarterly or monthly. ETFs often have smaller management fees compared to the other two types of funds. VOO for example has a management fee of 0.03% which is a large difference compared to the average management fee for mutual funds at 1.04%
Low cost: Typically ETFs have a lower monetary entrance compared to the other two. In other words, ETFs are cheaper and appeal to most beginner investors because they trade just like stocks. ETFs also make a great addition to your Roth IRA if you have one.
No minimum requirement: ETFs also don’t normally have a minimum amount you need to invest.
What is a mutual fund?
A mutual fund is a professionally managed investment fund that pools money from other investors to purchase securities like stocks or bonds.
That’s right, with mutual funds you combine your money with other investors to contribute to one fund that is divided among the participants.
Like ETFs, you can think of mutual funds as a basket of investments that focus on a certain sector or niche in the market.
They also often come with the highest management fee compared to the other two. Averaging at a range of about 0.1% - 2%.
So, if you invested $10,000 in a mutual fund, then you could pay as much as $200 in management fees.
How do mutual funds work?
An asset management company manages the pooled money that we were talking about earlier and they invest it in groups of stocks or other securities. These asset management companies are a team of market professionals that handpick the best securities to include in the mutual fund.
The investors will earn from a mutual fund in one of these three ways:
Capital gain: If the fund sells securities like bonds, stocks, or commodities that increase in price.
If your share increases: Since you own a piece of the pie, your share can increase if the securities perform well. This means you can then sell your share of the mutual fund for a profit.
Dividends: You can earn dividends from stocks and bonds included in a mutual fund which you can choose to reinvest or liquidate.
The argument for Mutual funds
Passive investing: You can invest in a wide range of securities without needing to keep track of individual stocks. Mutual funds technically require active management. But you pay fees so the asset management fees can do it for you.
Professional management: Compared to its little brothers(ETFs and Index funds), mutual funds are often managed by an actual person. Whereas the other two are managed by a computer. This can come with pros and cons as professional management means higher management fees.
What is an index fund?
Just like ETFs, index funds are built to have a similar performance as a major market index like the NASDAQ or S&P 500.
For example, The company Vanguard created an Index Fund called VFIX which mirrors the S&P 500.
A simple Google search will show you that VFIAX has a management fee of 0.04%. This is great in comparison to most Mutual Funds which hover around 2% for their management fees.
Another thing to know about Index funds is that they often have a minimum investment amount.
In Vanguard’s case, the VFIAX fund has a minimum investment of $3,000.
So, unfortunately, if you don’t have a couple of thousand dollars to invest, then index funds may not be the right choice for you.
How do index funds work?
The argument for index funds
Best passive strategy: Index funds are great passive investments since they mirror market indexes and don’t trade like stocks as ETFs do. You can’t buy and sell them in one day like you can with ETFs. This means potentially lower management fees since you would be charged extra commission fees if you actively buy and sell ETFs.
Index Funds often require a smaller management fee compared to mutual funds because they’re managed digitally rather than by a person.
Automation: They usually allow reinvestment perks and automated investing perks. This means you can set your index fund up so that you’re automatically investing X amount of dollars per month so you don’t have to worry about it all the time.
Index funds vs ETFs vs mutual funds...Which is better for you?
All three of these options are a great opportunity for you investor if you want to diversify your portfolio while not actively managing your investments.
So, how do you choose the best option for yourself?
One way you can break down your three options is to compare these different factors:
How easy it is to trade
Some index funds and mutual funds can be as low as a couple of hundred dollars. But in most cases, you’ll have to make a minimum investment between $3,000 -$10,000.
But an ETF on the other hand has little to no entrance fee compared to the other fund types. Since they trade like stocks, your brokerage may also allow you to purchase partial shares of ETFs.
For most beginner investors, ETFs are the way to go because of their cost and there isn’t much of a learning curve if you’re already familiar with buying and selling stocks.
Who do you think won the argument between index funds vs ETFs vs mutual funds?
The world of investment funds is a great way to grow your investment portfolio slowly but surely.
When you think of diversification, you don’t only want to diversify the types of stocks, but also the different types of assets you have in your portfolio.
So, your ideal portfolio can include ETFs, stocks, commodities (like gold), real estate, bonds, etc.
If you’d like to learn more about ETFs, check out our article, How to Double Your Money Every 7 Years With ETFs and The Rule of 72.
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