Mutual funds and exchange traded funds are important investment vehicles for your retirement. While both products allow for instant diversification and the ability to invest in nearly any asset class, they do operate differently.
Mutual Funds – Active and Passive Investments for Retirement
A mutual fund allows individuals to combine their money to buy investments, like stocks, bonds and cash. Professional managers take care of the stock and bond selection. Mutual funds may be actively managed or passively managed. An actively managed fund tries to beat its benchmark index. A passively managed fund, also known as an index fund, tries to match the performance of its benchmark index. Typically, index funds have much lower expense ratios than do actively managed funds.
Exchange Traded Funds (ETFs) – Passive Low-Cost Investments for Retirement
An exchange traded fund similarly allows for the instant purchase of a variety of investments. However, while mutual funds are bought, sold, and priced only daily, ETFs do so whenever the market is open. In addition, fees are usually even lower than index funds. While ETFs are occasionally more actively managed, the vast majority are of the passive variety.
Choosing Between Mutual Funds and ETFs
By shopping carefully, you can avoid trading costs associated with some mutual funds. Although this is starting to change, most ETFs require a commission to purchase or sell, since they trade like stocks. As such, when investing a lump sum, choosing an ETF is often more advantageous than a similar mutual fund, since you’ll the commission is typically a much less important factor in a large purchase and you’ll benefit from the low expense ratio on the entire purchase. On the other hand, if you are going to arrange for periodic investing to take advantage of dollar cost averaging, you may be better off choosing a mutual fund to avoid the trading costs.