Accounting for your life: managing funds
Investing in stocks is an expensive venture. Depending on the stocks you’re interested in, the price per share can be well over $1,000. Amazon (AMZN) and Alphabet (GOOG), for example, have a price per share of around $1,725 and $1,200, respectively. To own even one share of these companies would require a nontrivial sum, not to mention 10 or 20 shares.
Moving away from the high end of the spectrum, the cheaper options out there still boast substantial price tags. Companies like AT&T (T), Wells Fargo (WFC), and Coca Cola (KO) hover around $35 to $50 per share. While much more affordable than the $1,000+ per share mentioned previously, it’s still not cheap to become invested in these securities. You could opt for even cheaper stocks and possibly venture into the penny stock territory, but that often comes with higher risk and higher volatility.
Knowing this, wouldn’t it be great if there was an investment vehicle where you could own lots of companies at once without shelling out thousands of dollars at a time? That’s the exact philosophy behind both exchange-traded funds (ETFs) and mutual funds, both of which give investors diversification in holdings at a lower price as opposed to picking individual securities and investments.
ETFs and mutual funds are similar in that both have an underlying collection of investments, often focusing on one market sector. When investors buy into an ETF or a mutual fund, they indirectly invest the money into the securities contained in that fund rather than having to pay the price per share for each stock or investment, which means that the initial amount one has to shell out is a lot lower. This means that instead of buying shares of Exxon (XOM), Apple (AAPL), and Adobe Systems (ADBE) separately, you can buy into a fund that tracks the S&P 500 and invest in these and many other stocks automatically for a far lower price. Investing in a fund means you’re investing in a pre-made portfolio and your fortunes depend on how well the constituents of that portfolio are doing.
With a low price tag, instant diversification, and more balanced risks, it’s easy to see why funds are so popular: they take the guesswork out of investing and are a great way for beginning investors to gain a foothold in the market, especially those who do not have the time to monitor the market and want a passive investment approach. Furthermore, most funds only boast a modest expense ratio: the fees you pay for owning some of the funds. This means that the amount you’re losing to fees is generally outweighed by your gains, though this is highly dependent on the performance of the ETF.
There are two key differences between ETFs and mutual funds that are important to understand before investing in either one. First, ETFs are traded like stocks, whereas mutual funds are traded only at the end of the day. This means that if you want to buy 50 shares of an ETF, the Vanguard S&P 500 ETF (VOO) for example, you can execute that order instantly and get the market price you saw at the instant that you decided to buy. Once the order is executed, you then own 50 shares of the ETF and that’s that. ETFs can also be traded like stocks, so selling and buying them are performed like any other routine transaction on the market.
Mutual funds, on the other hand, are traded at the end of the day. For example, say that you wanted to buy into a mutual fund during the trading day, and say that its current trading price is $40 per share. You then initiate a trade by putting up $1000, but the trade is not executed at that moment. Instead, you must wait until 4:00 pm EST before the trade goes through, and your $1000 is used to purchase as many shares as possible at the closing price. Thus, purchasing a mutual fund puts you at risk of price fluctuations throughout the day.
The second key difference is that mutual funds are actively managed while ETFs are not always managed. This means that an actual portfolio manager is overseeing the operations of the mutual fund, whereas ETFs are passively managed and simply track their target market sector. While it may sound comforting to hear that your money will have more oversight in a mutual fund, it’s important to note that most actively managed funds fail to outperform passively managed funds in the long-term. It’s for this reason that in recent years, ETFs have become more popular than mutual funds as an investment tool among both active and passive traders. Simply tracking the market rather than trying to game the market leads to average and consistent returns over time and minimizes the risks that come with frequent buying and selling of securities. That’s not to say that ETFs and passively managed funds never change: all funds are rebalanced depending on the performance of the market, so fund compositions are rarely immutable.
So, with this general oversight of ETFs and mutual funds, the question remains: how do you invest in these funds?
The answer is simple, just go out and buy shares of a fund via online trading or brokerage account! With online trading services from companies like Vanguard and Fidelity, buying securities on the market is easier than ever. Of course, before you buy you should first do your research on what the fund is focused on and what its outlook is. If a prospectus is offered, and it usually is, take the time to read it. The prospectus is a packet of information for potential shareholders and outlines both the expenses of investing in the fund and its major holdings, as well as the projected growth of a $10,000 investment. And as always, when it comes to buying securities, understand that your time in the market is more important than timing the market. This is especially true with funds since you are exposed to a mix of investments rather than individual company stocks. Holding on to investments for the long term is better than rapid buying and selling since you don’t miss out on long-term growth and dividend payments. Volatility in the short-term is unnerving, but understand that in the long-term, the market generally trends upwards. There is always the risk of losing money when investing, so be sure that you never invest more than you can afford to lose.
Next time, we’ll talk about trading commodities on the market and how things like oil, gold, and silver can be traded much like stocks.