With all the volatility of the stock market, it may be comforting to remember that past trauma in the market has led to benefits for today’s investors. One such benefit: The exchange traded fund, or ETF, which was spawned from the ashes of the 1987 stock market crash.
You see, institutional investors at the time of the ’87 crash found that they’d have been best served by being able to quickly trade large numbers of stocks, preferably before the exchange closed for the day. An initial attempt in 1989 to set up something like an ETF based on S&P 500 stocks never got off the ground; the Chicago Mercantile Exchange sued to stop its launch.
Then, an L.A.-based investment firm grouped stocks together as one unit and traded that unit on the exchange as a sort of precursor to the ETF, but it didn’t pan out. Maybe it was ahead of its time, or maybe there was such a high minimum investment that run-of-the-mill investors just weren’t interested.
Standard & Poor’s Depositary Receipts (SPDRs) that tracked the S&P 500 index debuted in 1993. These shares were much less expensive and attracted both institutional and individual investors. Due to their combined liquidity and affordability, SPDRs took off and launched the phenomenon of the exchange traded fund.
Today, investors may get a little confused about the differences between ETFs and mutual funds. After all, they are both groups of stocks that can be purchased without a huge minimum, and they appeal to nearly all investors.
Which is the best option for your portfolio? What are the pros and cons of each? Let’s look at the real differences between the two.
What is an ETF?
Just like its name implies, an exchange traded fund is a basket of securities that trade on an exchange, similar to a stock. And, like a stock, the price of an ETF can go up and down all day long.
The investment groups that create ETFs can group other types of investments, not just stocks. Types of ETFs including those for commodities, currencies and bonds. The creators decide whether securities are U.S. only or international as well as whether they follow a particular industry, though almost all are connected to an index. Like a stock, ETFs can be sold short and can also allow for arbitrage due to their continual pricing by the market, should an investor wish to engage in rapid-fire trading or speculating.
Why does an individual investor — especially one taking a long-term approach — care? Because they’re grouped as one unit, ETFs won’t set you back all the broker commissions it would cost to buy stocks individually. The expense ratios are usually low, as well, due to an ETF typically tracking a specific index. Investors can also earn dividends on ETFs.
What is a Mutual Fund?
Like ETFs, mutual funds are also groups of securities packaged together for ease to the investor. These funds are usually managed by one person or a small team that makes decisions about what securities should be purchased and sold to maximize profit. Because mutual funds are actively managed, they will cost more than ETFs typically do.
As well, most mutual funds require a higher initial investment, though that depends on the specific fund and managers. The price to invest in a mutual fund can be 10 times that of getting started in an ETF.
Another key difference is that mutual funds are valued once a day, at the end of the trading day. Because net asset value isn’t continuously being determined, like with ETFs, there’s no option for arbitrage. In fact, people investing in mutual funds buy and sell directly to that fund, not to an exchange, which somewhat limits liquidity.
Mutual funds can be open ended, meaning that the fund will issue as many shares as investors want to buy, or they can be closed with a specific number of shares available whether or not there is increased demand.
Investing in an ETF vs. a Mutual Fund
Both exchange traded funds and mutual funds are great ways to diversify because they incorporate a range of securities in one, easy-to-purchase fund. The type of investor you are will dictate whether you’re more comfortable investing in an ETF or a mutual fund.
When you invest in a mutual fund, you’re giving your money to others to actively manage. If you want human expertise and decision making to play a major role in your investing, but you don’t want to make those decisions yourself, a mutual fund is a good option for you. You’ll need a relatively high initial investment and you may pay more fees, but you’re leaving the driving, so to speak, to qualified fund managers.
On the other hand, an ETF is passively managed because they’re usually tied to a specific type of index and will go up and down as that index does. If you’re willing to take the risks of investing on an exchange but want to spread out that risk over several securities rather than one individual stock, ETFs are a great investment vehicle. You can also invest with a much smaller outlay and can quickly pivot should you wish to sell or want to take a more speculative approach.
How Magnifi Can Help
Whether you’re interested in mutual funds, ETFs, or a mix of both, Magnifi can help investors find the right vehicles for their investment dollars. When you use Magnifi to find investment opportunities, you can take advantage of their semantic search tool that uses the meaning behind your searches, and not just keywords, to identify the best options for your needs.
With Magnifi, there’s no need to spend hours conducting research. Use natural language to make your query and you’ll turn up a manageable range of options that may be of interest — just like Spotify suggests music or Netflix recommends movies based on your search.
Whether you’re a newbie or an experienced investor, Magnifi helps you sift through the thousands of funds out there to hone in on the options that meet your interests and requirements. Maybe you’re interested in a particular industry or region and you want funds that meet those needs. You can further sort by fees, volume, assets, risk or return, as well as by the type of vehicle, sponsor, asset class or philosophy toward investing. Make your searches more or less restrictive until you find the ideal investment for you.
Regardless of whether you choose to invest in mutual funds or ETFs, you can find the right funds with help from Magnifi.
Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Try it for yourself today.
This blog is sponsored by Magnifi. The information and data are as of the publish date unless otherwise noted and subject to change. This material is provided for informational purposes only and should not be construed as individualized investment advice or an offer or solicitation to buy or sell securities tailored to your needs. This information covers investment and market activity, industry or sector trends, or other broad-based economic or market conditions and should not be construed as investment research or advice. Investors are urged to consult with their financial advisors before buying or selling any securities. Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. Past performance is no guarantee of future results. This content may not be reproduced or distributed to any person in whole or in part without the prior written consent of Magnifi. [As a technology company, Magnifi provides access to tools and will be compensated for providing such access. Magnifi does not provide broker-dealer, custodian, investment advice or related investment services.]
