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Mutual Funds and Exchange Traded Funds: A Crash Course

If you have ever wanted to get started on investing and stock trading you have almost definitely heard that indexes are the place to start. Indexes can be split into two categories: mutual funds and exchange-traded funds. Both types share a lot of commonalities. The main difference however is the way these assets are managed. ETFs resemble stocks as they can be traded throughout the day; mutual funds on the other hand can only be purchased at the end of each trading day based on an established price. In addition, compared to ETFs, mutual funds are more actively managed by a fund manager which picks and chooses the best investment opportunities to put your money into.

So why are indexes useful? Well, mutual funds and ETFs are based on a type of investment where funds from various investors get pooled together to purchase a variety of stocks and other investments. This means you can now effectively invest in hundreds of the largest companies, such as Apple, Microsoft, and Facebook, without needing to spend thousands of dollars.

With the ability to invest a little and the benefit of all your fund being diversified to hundreds of different locations, you also minimize your risk. You also typically do not need to worry about day-to-day fluctuations nor volatility within a single company. Indeed, a hit in an individual industry (like tech) will not affect such funds as much as investing in technology companies individually yourself.

If there is one specific industry you would like to invest in specifically but still want the benefits of diversification offers, there are specific indexes that track and invest in just those companies as well. For example, iShares Global Clean Energy ETF tracks investment results of an index made of global equities in the renewable and alternative energy sector. Although this still has diversification as an underlying benefit, by focusing on a single industry it is more prone to sudden peaks and troughs compared to a fund that invests in opportunities in a variety of industries. In the end this is a personal decision which involves risk tolerance and outlook.

Mutual vs. Exchange-Traded Funds

There is no need to do massive research when you invest in funds

Another point to consider is that there is also much ease in investing in mutual funds and stock market indexes. Specifically, you do not need to do massive amounts of research about dozens of individual stocks. Comparatively, there are some “gold standards” for index funds and mutual funds, such as the “S&P 500.”

If you decide to dollar cost average, which is an investment strategy where small regular sums are invested, you also have to worry less about “timing” the market. Finally, it is much more predictable than some other investments. For example, the average annual return since its inception in 1926 through 2018 is 10-11%. 

Although they still have fluctuations, such indexes and funds are great places to start for someone that may want an investment opportunity with low time commitment and for the long run; however, as with any investment, ensure you do your own research!

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