By Judy Loy
Registered Investment Advisor, ChFC®, RICP® and CEO of Nestlerode & Loy, Inc.
In my last article, I gave an overview of stocks and fixed income/bonds. In this article, I will give an overview of mutual funds and exchange-traded funds (ETFs). Mutual funds and ETFs contain other investments inside of them.
Mutual funds have been around a long time. The first modern mutual fund launched in the U.S. in 1924 and the oldest mutual fund still in existence is the Vanguard Wellington Fund (VWELX), which started in 1929. Mutual funds pool money from investors to purchase investments, which can include stocks, bonds and/or other assets. They are a great way for a small investor to build their wealth.
Once you invest the initial minimum, it will permit investors to put monthly amounts away (say $50) into the fund, which allows for diversification with small monthly commitments. When buying a fund, the investor buys from the mutual fund family at the end of the business day. Mutual funds are not openly traded on the markets but only sold or purchased directly from the mutual fund company. The price of the fund reflects the values of its holdings at the end of the day, this is called the Net Asset Value, or NAV. Mutual funds are still the most common investment available in employer retirement plans (401k, Simple IRAs, etc.).
Because mutual funds invest in securities, they do involve risk and are not guaranteed. The level of volatility and risk depends on where the mutual fund invests your money.
Mutual funds also have different cost structures. For instance, front-load mutual funds (typically also called A Shares) charge an initial sales charge to pay the advisor to service and suggest the fund. In this instance, the investor pays the MOP (maximum offering price), which is the NAV plus the sales charge per share when purchasing.
There are level load funds (commonly denoted as C shares), where the investor pays a higher underlying fee annually that is paid out to their advisor. The third load fund is back-end sales charge, typically called B shares. These are going the way of the dinosaur as they were usually not in the investors best interest. They would have a load if the sales were sold within so long of a time from the initial investment.
A, B and C shares are all load funds and typically sold with the advice and expertise of a broker that gets paid a commission. No load funds are sold directly to investors or through fee-based advisor directed accounts. No loads are exactly as described: there are no load charges. However, all mutual funds have underlying costs, which include operating expenses and trading. These come off the returns of the mutual fund. Index funds tend to be the least expensive funds because they do not require management.
As compared to a lot of investments, exchange-traded funds (ETFs) are a new kid on the block. The first ETF was created in Canada in 1990.
An ETF is another pooled investment but unlike a mutual fund, exchange-traded funds trade throughout the day on exchanges (thus the name), like individual stocks. As with mutual funds, ETFs can be invested in many different underlying assets and are not guaranteed. Unlike mutual funds, an ETF can trade at a premium or discount to its NAV, which means sometimes you are paying more or less than the underlying assets are worth because of market conditions.
ETFs tend to have lower costs than mutual funds because a majority are index funds. The downside is it is harder to make small purchases into an ETF monthly unlike a mutual fund.
This is a simple overview of these two types of investments. There are many different types of mutual funds and ETFs to cover your investment needs. To learn more, talk to your advisor.
All investing is subject to risk, including possible loss of the money you invest. Nothing in this article should be construed as investment or retirement advice. Always consult with a professional advisor and consider your risk tolerance and time to invest when making investment decisions.
