Investing in a Mutual Fund or ETF
Mutual funds and ETFs enable investors to quickly diversify their portfolio; yet, these two types of funds differ individually in terms of management style and cost.
Mutual Funds
A mutual fund pulls capital from several investors and is actively managed by a professional who oversees all trading decisions. Investors purchase shares of a mutual fund at the end of each day, based on its current net asset value or NAV (net asset value). Investors then own a percentage of the fund, based on the number of shares they purchased.
Investors receive returns from the mutual fund in the form of dividends, interest payments from the underlying securities; capital gains that the fund experiences, and the redemption of shares at their NAV if the underlying holdings increase in price. Many advantages come with investing in a mutual fund, including access to a professionally and actively managed fund. Furthermore, mutual funds can quickly diversify a portfolio as it invests in hundreds of stocks. Diversification maximizes returns by investing in a wide range of securities, each of which reacts differently to the same occurrence.
However, the biggest disadvantage of mutual funds is high fees. The fees are broken down into ongoing annual charges to cover transaction fees and management fees.
ETFs
An ETF is structured similarly to a mutual fund, but trades like a stock on an exchange. ETFs are passively managed and their performance is meant to track underlying indexes, including sectors, fixed income, global investments, commodities, and currencies. ETFs are unique due to their ability to be traded throughout the day on the secondary market, at a price that resembles the underlying NAV; but is independent of it. ETFs have significantly lower annual fees compared to mutual funds.
Overall Benefits of Investing in Mutual Funds and ETFs
There are several reasons why investors would like to invest in a mutual fund or an ETF instead of an individual stock. First, mutual funds and ETFs are safe choices for investors who simply do not have enough time to do the necessary research and monitor all investments; instead, the mutual fund or ETF manager assumes the responsibility of handling these time-consuming tasks. Secondly, many investors lack the proper knowledge required to make investments and would prefer to trust a professional with their money, rather than undertake the process themselves. If an investor lacks the resources for designing a diversified portfolio, then investing in a mutual fund or ETF is an excellent alternative for achieving the same result.