There is a common saying in investing that goes like, “don’t put all your eggs in one basket.” Essentially, this phrase is a way to describe diversification. You, as an investor, could buy a handful of individual stocks without building a portfolio that is as diversified as an index. For example, if you bought one share of each company in the S&P500 index, it would cost approximately $74,000. There are, nonetheless, easier ways to diversify your portfolio. Mutual funds and exchange traded funds (ETFs) can be an efficient and easy way to achieve diversification. You may not be familiar with these concepts, so this article will explore both types of funds.
What are Mutual Funds?
Mutual funds have been around longer than ETFs. A large portion of company 401(k) plans utilize mutual funds for their investment options; however, individual investors can purchase mutual funds as well. To provide the built-in diversification, mutual funds will pool the money of numerous investors together. The funds will have their own unique investment objective and strategy and can feature both stock and bond investments. Some funds track indexes, while some track sectors of the economy such as technology, energy, or financials. The management aspect of the mutual fund can be either active or passive.
From a trading logistics standpoint, mutual funds trade one time per day after the market close. Many funds have initial and subsequent investment requirements, meaning that one is required to purchase a minimum dollar amount. Mutual funds also pay capital gain distributions to shareholders regardless if they have sold their investment.
Explaining Exchange Traded Funds (ETFs)
Exchange traded funds (ETFs) are newer to the investment world by comparison. ETFs share a lot of the same attributes as mutual funds, as the built-in diversification and elements of portfolio management exist in both styles of funds. Some key differences with ETFs include investors are able to buy as little as one share of the ET, and ETF shares trade like stock, so the price fluctuates throughout the day as trading occurs. Investors in ETFs can buy as little as one share. Capital gains taxation of ETFs occur when investors buy or sell their shares, therefore, they don’t have capital gain payouts like mutual funds.
Considerations for Your Portfolio
Mutual funds and ETFs provide value for investors and should be taken into consideration for portfolios. They both offer built-in diversification and account management aspects at a cost savings compared to building the portfolio on your own. Due to the differences in handling capital gains taxation, you might choose to have mutual funds in a qualified account and ETFs in a taxable or qualified account. According to Statista.com, there are 8000 mutual funds, 2000 ETFs, and $20 trillion in assets under management.
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This is not a solicitation or recommendation to purchase or sell any investment product or service, and should not be relied upon as such. It is not possible to directly invest in an index. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The views and strategies described may not be suitable for all investors.
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