Mutual Funds or ETF’s – Which Is Better For You?

There are several investments and investing styles to choose from. Mutual funds, ETF’s, stocks, bonds, CD’s, preferred stocks, the list goes on. More than likely you have a variety of investments that combined, make up your investment portfolio. These investments should line up with your risk tolerance and desired goals. But what are the differences between mutual funds and exchange-traded funds (ETF’s)? Let’s break it down.

Mutual Funds

You may have a college savings account, or 529 account, a 401K, or a personal investment account. These are just a few examples of mutual funds. A mutual fund is a pooled investment vehicle that is managed by a professional money manager. Think of a mutual fund as a bucket. Into that bucket you can put any number of things – stocks, bonds, futures contracts, and other types of holdings, then you buy and/or sell shares of that bucket. When you buy shares of a mutual fund you’re buying a small slice of each item in that bucket. The professional money manager on the other end is taking your money, along with monies from hundreds, thousands or even tens-of-thousands of other people and buying the investments that have been outlined in the prospectus.

Required by the SEC, a prospectus is something every mutual fund is required to generate on an annual basis. It outlines all the parameters of your mutual fund - facts about the company (or fund), its finances, management and other information for investors. It’s typically a bulky document with a lot of fine print but if you have any questions about your mutual fund, the answer is probably in the prospectus.

Mutual funds come in many shapes in sizes. You may have a mutual fund which invests in equities or stock of publicly traded companies. They may hold bonds or debt instruments, or they may hold cash. Mutual funds can also contain holdings not only in the U.S. but around the world. To that end, they may concentrate on a specific geographic region of the world. There are countless different mutual funds. That said, make sure you understand what you have. Understand the parameters of how they invest and how they can change. Also, and it can happen, understand how the professional money manager can change because the style of the fund may shift as well.

Valuations of mutual funds can fluctuate positively and negatively. Meaning there is no promise of return. It is an investment and with it comes some risk. An aggressive approach is great when a fund is growing but it also may have some short-term downside possibilities. If you are more conservative it may not have as much growth possibility, but it may protect you more on the downside. By investing in a mutual fund, you are taking some risk in the hopes that there will be long-term appreciation over time. Again, understand what type of mutual funds you have and whether they work within your risk tolerance and will help you to meet your goals.

The prospectus outlines what type of investments you have - domestic, international, stocks, bonds, cash instruments, and others – as well as the expense ratio. What is an expense ratio? An expense ratio is an expense which is debited from a mutual fund on a daily, monthly or annual basis. The expense ratio is how the money manager and financial advisor are paid, and the trading costs and ownership costs of the instruments of that fund are paid. Make sure you understand what your expense ratio is for each mutual fund because it has a direct impact on your bottom line.

If you have a fund with a higher expense ratio it will have a larger impact on your bottom line. But with a higher expense ratio you will probably see funds that are a little more aggressive or more dynamic in nature. So, it may have some higher possibilities for upside. Sometimes with a more conservative fund you will see a lower expense ratio perhaps because they are more passive investment styles or there isn’t as much activity. Of course, there are a few reasons for the range of expense ratios.

If you own more than one mutual fund, understand the interrelationship between them and how they perform compared to one another. You may have funds that are invested in very similar ways. This is called investment overlap. If investment overlap is your desire, then that’s perfectly fine. However, when looking at your portfolio analysis, your financial planner is probably looking for some diversification. You want to touch different parts of the investment universe so that when things fluctuate, you have some protection. Again, talk to your financial planner about your short and long-term goals along with your risk tolerance so they can help develop the right plan for you.

ETF’s

Not to be confused with mutual funds, there are exchange-traded funds or ETF’s. ETF’s are funds that track or invest in certain stock indexes or bond indexes and are traded on the stock exchange during the trading day just like shares of stock. They trade by the hour, minute and second. On the other hand, mutual funds only trade one time per day.

With an ETF you may be tracking an index. You also have the power to buy and sell at different prices and ranges if you choose to do so. Make sure you understand how ETF’s go together, how they are constructed, and how they move. Recognize the history of the ETF’s, the good time and the bad times, to see the much larger picture. An ETF is not static but rather something that will need to be tweaked in response to how the markets are moving, and to any changes you make in your life.

ETF products, like all investments, are subject to market risk, which may result in the loss of principal. Risks vary depending upon the strategy used by the fund as well as the sectors in which the fund invests. Mutual fund investments are not guaranteed by any source and can lose money including principal invested. Note: Differing classes of shares have varying expenses, loads, fees and breakpoints. These differing classes also have time line holding periods which are appropriate depending on the investor objectives and goals.

Interested in hearing more about this topic? You can listen to the full episode of the North Main Financial radio show on WSIC by clicking here: Episode:  10-06-18 “Mutual Funds and ETFs”

If you have questions or would like to talk with us further about our services, give us a call at (704) 987-1425 or visit us at www.northmainfinancial.com. If you wish to schedule an introductory meeting, we would be happy to meet with you at no cost or obligation to you.

These Blogs are provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of SagePoint Financial.