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How Mutual Funds and ETFs Build Wealth

  December 28, 2021  |    #Make Money

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Mutual funds and ETFs

Want to grow your wealth for financial security and your retirement? Here’s why mutual funds and ETFs should be the keystone to your investment plan. Add them to your portfolio and eliminate credit card debt from your portfolio. Eliminate debt easier with the 7-Step Credit Card Debt Slasher.

The power of mutual funds and ETFs

We keep saying that there’s no part of the economy designed for success quite like the stock market, but investing in stocks can feel daunting and it scares many people away. That’s why we’re sharing with you everything you need to know about mutual funds and ETFs – or exchange-traded funds – investing to grow your wealth, financial security and retirement savings.

Hear what you need to about mutual funds and ETFs:

What you should know about mutual funds?

1. What are mutual funds?

Mutual Funds are a basket of investments pooled together to create a unique investment product.

Mutual funds may be comprised of other investments, such as stocks, bonds, treasuries, annuities, cash, and more. The types of investments that can be held in mutual funds are unlimited.

Mutual funds are like little businesses. Managing the allocation of mutual fund investments to meet the mutual fund’s investment objective requires a mutual fund manager, support staff, marketing, research and development and more that require money. To fund this business, mutual funds charge an “annual operation expense” from their mutual fund investors.

2. What types of mutual funds are there?

A stock mutual fund holds many different stocks. Often certain stocks are pooled together to create a specified investment objective for the mutual fund. For example, a “large capital mutual fund” is mostly comprised of stocks of companies with which you’re likely familiar, such as Apple, Exxon Mobile and Wal-Mart. An “emerging market mutual fund” may be comprised of stocks in companies from lesser developed nations, such as Taiwan, Brazil and Uganda.

For any segment of the world economy in which you may want to invest or any investment objective you personally have, there is a mutual fund for it.

The most prolific types of mutual funds are index funds, which track standard market indices, such as the S&P 500 for large-capitalization stocks or the Russell 2000 for small capitalization. There are other indices and there are mutual funds that track them.

Your best resource for learning about a mutual fund’s investment objective, expenses and other details is the mutual fund’s prospectus. This can be requested from your stock broker, accessed online or requested from the mutual fund company. A good rule of thumb is to never invest in a mutual fund without first fully understanding all its nuances.

3. What are the rewards and risks of owning mutual funds?

The main risk with owning mutual funds, as currently highlighted by the Lockheed Martin settlement last week, is that many mutual funds have very high annual operating expenses. It is believed that many times these expenses are higher than they should be, relative to comparable funds (similar investments and performance) with lower expenses.

The lowest cost mutual funds are typically index mutual funds. That is because these funds track a pre-existing index. Managers for these funds mostly buy and sell investments similar to the investments that comprise the indices.

For mutual funds that don’t track an index, called actively managed funds, fund managers and their staff must make investment decisions based on the mutual fund’s stated investment objective. This can be a very complicated process, which justifies a higher fee than that of index mutual funds.

Passive mutual funds frequently beat the more expensive actively managed funds. For example, according to a Goldman Sachs study, 85% of actively managed large-cap funds are trailing the S&P 500 Index year-to-date in 2014. There’s not much time left for actively managed mutual fund managers to turn things around.

Ironically, the rewards of owning a mutual fund are that they provide an investment manager for those not well versed in investing or without the time to pay close attention to their investments. An additional benefit is that with just a few different mutual funds with different investment objectives, an investor can be well-diversified. Diversification reduces investment risk and exposes an investor to more of the benefits of investing.

That’s what you need to know about mutual funds. With this basic understanding of stocks and mutual funds, you now have considerable knowledge about the most popular and prolific investment types.

What you should know about ETFs?

1. What are ETFs?

ETFs comprise some characteristics of stocks and some characteristics of mutual funds. They work similarly to mutual funds and trade like stocks.

Similar to mutual funds, ETFs are baskets of other investments pooled together to create a unique investment. This pool of investments can consist of stocks, bonds, commodities and other investment types.

Unlike mutual funds that trade daily after market close, ETFs are traded throughout the day and their prices are adjusted in real-time like stocks. Also, like stocks and unlike mutual funds, ETFs can be sold short and purchased on margin.

2. What types of ETFs are there?

The most prolific types of ETFs track narrow market indices, such as the S&P 500 for large-cap stocks and the Russell 2000 for small-cap stocks. There are other ETFs that track broader indices with various investment objectives, such as international growth, technology and many others.

3. What are the rewards and risks of owning ETFs?

The rewards of owning ETFs is that they are tax advantageous, easily provide diversification and have lower fees. Most ETF gains are reinvested back into the ETF and avoid a taxable event.

As with mutual funds, because ETFs comprise many investments, they easily allow for diversification. This diversification reduces an investor’s risk of “having all eggs in one basket” and positions them to take advantage of the gains that are available in the market.

Lastly, because most ETFs track an index, they don’t require active management. Because of the lower requirement for active management, ETFs don’t carry the high fees that some mutual funds do. An investor can, however, increase their cost of ETF ownership through excessive transaction fees or commissions if they frequently trade their ETFs. Such excessive trading can increase their taxes if these transactions aren’t done in a tax-sheltered retirement account.

Every LGBT person who has access to a 401(k) or a retirement plan through their employer needs to be using it. And when you use a 401(k), often, you’re going to have access to investing in mutual funds and ETFs. - David of Debt Free GuysClick To Tweet

Even though ETFs provide diversification, they do have a more narrow focus than some mutual funds. In fact, some ETF niches are so narrow in focus that they lack liquidity. This means that there aren’t a lot of buyers and sellers. For example, there are many more investors buying and selling Apple Corporation stock than there are for Weibo Corporation stock. Though most everyday investors wouldn’t likely notice, this makes buying and selling some ETFs harder.

That’s what you need to know about ETFs. With this basic understanding now of stocks, mutual funds and ETFs, you have a greater knowledge of investment types than most Americans.

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Resources to help you with mutual funds and ETFs:

5 Building Blocks of a Happy Gay Life

We’re David and John Auten-Schneider, the Debt Free Guys and hosts of the Queer Money® podcast. We help queer people (and allies) live fabulously not fabulously broke by helping them 1) pay off credit card debt, 2) become part- or full-time entrepreneurs and 3) save and invest for retirement.

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Avoid these 7 mistakes to get on the fast path to wealth.