Investors looking for diversification often turn to the world of funds. Actively managed mutual funds, index mutual funds, and exchange-traded funds (ETFs) can provide broad, diversified exposure to an asset class, region, or specific market niche without having to buy scores of individual securities.
The challenge lies in narrowing down your options. Let’s look at some of the benefits and drawbacks of each—and how they may fit your needs.
Mutual funds
Generally speaking, there are two types:
· Actively managed funds: The investments in these funds are selected and managed by a portfolio manager or team, generally with the goal of outperforming the market.
Of course, such expertise comes at a cost: actively managed funds tend to charge higher fees than ETFs and index funds that attempt to mirror (rather than beat) the market. Be aware, too, that all the expertise in the world doesn’t guarantee that an active fund will outperform the market.
· Index mutual funds: These funds generally seek to replicate the performance of a particular index—also known as passive management—which typically results in lower expense ratios than actively managed funds. They can be an attractive option for investors looking for a low-cost way to capitalize on the long-term direction of the market.
That said, passive fund managers have little ability to change course in the midst of a market downturn or rally, so investors looking for more defensive and/or aggressive management styles may find active funds more attractive.
ETFs
Like index mutual funds, ETFs generally are passively managed and offer similar investment strategies (and charge similar fees) to traditional index mutual funds. However, ETFs trade on national market exchanges just like stocks and, as such, may incur trading commissions (though many brokerages now offer commission-free ETF trading).
The ability to trade ETFs intraday means investors can employ the same order types allowed with traditional equities—something that’s unavailable with mutual funds because of the way they’re bought and sold. That said, sometimes a niche ETF that isn’t traded frequently may have a wide bid-ask spread, which can indicate it may be difficult to sell, and in such cases there may be a mutual fund that’s preferable.
Don Daigle is a Financial Consultant at Charles Schwab with over 30 years of experience helping clients achieve their financial goals. Some content provided here has been compiled from previously published articles authored by various parties at Schwab.
Don Daigle
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Investors should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges, and expenses. Please read it carefully before investing.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
Indexes are unmanaged and you cannot invest in them directly.
Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV).
