Ready, Set, Invest: Discover the Best Fund for Your Financial Goals

Hi Reader,

Welcome to The Money Series and if you are new here, thank you for signing up. Personal Finance can feel ambiguous and overwhelming, but I am here to help simplify the journey.

Over the past three weeks, we have examined Mutual Funds, Index Funds, and Exchange-Traded Funds (ETFs). Today, let's recap their key similarities and differences to help you make informed investment decisions.

Mutual Funds were the first pooled investment vehicle, dating back to the 1800s. They allowed investors to pool their money together to invest in various assets, benefiting from diversification. In the 1970s, Index Funds emerged as a new type of mutual fund, offering a low-fee, passively managed alternative to traditional mutual funds. More recently, exchange-traded funds (ETFs) entered the market, combining the diversification of index funds with the flexibility of stock trading.

Commonalities among Mutual Funds, Index Funds, and ETFs:

Convenience. A single transaction gives you ownership of a fraction of all the underlying assets

Variety. These funds offer a wide selection of assets (remember the layered sandwich analogy from our earlier discussion on mutual funds).

Diversification. They help reduce risk by spreading investments across multiple assets, making it easier to achieve diversification than doing it on your own.

Key Differences:

Mutual Funds

• Active Management. Most mutual funds are actively managed by professional fund managers. This means a manager(s) actively decides to buy or sell a stock in the fund. Compensation for the managers means Mutual Funds charge higher fees. 1-2% per year is charged and referred to as 'expense ratios’.

• Performance and Costs. Even if the fund performs poorly, the manager still gets to charge 1-2% of the value of the fund. A 1% annual fee can result in as much as a 28% reduction in your investment portfolio over two decades.

• Objective. Mutual Funds seek to beat the market but don't always.

• Not All Mutual Funds Are Index Funds. While all index funds are a type of mutual fund, not all mutual funds are index funds. Index funds specifically track a market index and disclose which one they follow.

Index Funds & ETFs

• Passive Management. Both index funds and ETFs are typically passively managed, meaning they are designed to mirror the performance of a specific index. Because of this, they have low fees. Some index funds charge as little as 0.04% per year—equivalent to paying just $4 annually on a $10,000 investment.

• Performance. These funds often match the risk and return of their benchmark index and have outperformed actively managed funds over time.

• Trading Frequency. Index funds trade only once per day after the market closes.

ETFs

• Tradability. The main difference with ETFs is that they trade like stocks. You can buy or sell them at any time during market hours, providing flexibility.

• Transaction Costs. Like stocks, ETFs may incur commission fees when purchased or sold through a brokerage firm.

• Fractional Shares. Some online brokerages now allow you to purchase fractional shares of ETFs, making it easier to invest with smaller amounts. In contrast, some index funds may have minimum investment requirements.

See below for a summary of the peculiarity of each type of investment.

Which Investment is Right for You?

Mutual funds:

• If you are seeking professional management and are willing to pay higher fees, mutual funds might be suitable.

Index funds:

• Offer automatic dividend reinvestment, making them ideal for long-term investors.

• Allows you to set up recurring monthly deposits automatically purchasing more shares without extra effort or fees.

ETFs:

• Offer flexibility, allowing you to trade during market hours and access specific indices.

• However, frequent trading can lead to impulsive decisions (and high transaction costs) that may hinder long-term wealth building. ETFs are more suited for traders or short-term investors.

If you're unsure whether to choose ETFs or index funds, index funds are often the better option for passive, long-term investors. They offer hassle-free automatic reinvestment and allow for regular, automated contributions without the need for manual trades or additional fees. ETFs, while flexible, require more hands-on management and can incur transaction costs each time you buy shares.

You generally can’t go wrong with index funds or ETFs, but with mutual funds, it's essential to watch for high fees that could erode your returns. Always keep an eye on expense ratios when making your investment decisions.

Feel free to send in your questions; they might influence the next newsletter!

Act Now:

• Decide which of the three investment vehicles works for you

Reflect on This:

• What % of your savings are you investing and why?

Till next week, I am rooting for you, money-ly!

Dee

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Disclaimer: This does not constitute financial advice. Please conduct your research or consult your financial advisor for important financial advice.