Investing 101: Understanding Funds & ETFS (in Plain English)
We covered the basics on learning what stocks are in the last blog (you can catch up and read it here) - so now it's time to learn a little about all of those unfamiliar names that you see on the menu of choices for your 401(k) or 403(b), depending on the retirement plan offered by your employer.
I know it can seem overwhelming, but that's why we're here to help!
What are all of these options in my 401(k)/403(b)?
Your retirement plan at work offers you different choices of where to invest your money for retirement (stocks, bonds, domestic/foreign, mixtures, and more).
The overwhelming majority of these options are going to be either mutual funds or ETFs (Exchange Traded Funds). You might also have the option to purchase company stock, but we're not going to cover that here.
One of the main goals of a mutual fund or ETF is to provide diversification. There's an old adage about "not putting all your eggs in one basket" - and the concept applies very well to investing.
What is a mutual fund?
A mutual fund is a collection of investments selected and managed by people at a mutual fund company. Of course, these people are aided by technology and lots of complex math, but. at the end of the day, the humans decide which stocks to buy/sell/hold. You may also hear these described as "actively managed funds" - which means exactly what it says. People are actively managing this set of investments.
These funds can have all different kinds of objectives: aggressive growth, moderate growth, produce income, preserve money, etc.
Potential upsides of mutual funds:
- Professional management - the fund's managers do a ton of due diligence and research on the investments they select to align with the objective of the fund.
- Wide variety of choices - you can be very specific about your investment goals and likely find a fund that will closely align with your goals
Potential downsides of mutual funds:
- Costs - mutual funds may charge different types of sales charges, fees, and expenses to clients.
- Lack of transparency - most funds to not publish all of their exact holdings, you may get just the top 10
- Humans - remember that humans manage these funds, and humans are prone to errors, poor judgment, and even worse.
What is an ETF?
An ETF (exchange-traded fund) is similar to a mutual fund, in that it holds a broad range of different investments. The big difference is how the investments are owned.
There are no humans deciding what to buy or sell in an ETF, you just get the investments that are pre-selected and hold on to them. (Note: for any finance nerds out there, I'm excluding active ETFs to keep things simple)
ETFs can also be specific about the different types of investments they hold.
Potential upsides of ETFs:
- Costs - many ETFs have significantly lower costs than mutual funds.
- Diversification - ETFs can provide instant diversification without having to select individual stocks.
- Transparency - most ETFs disclose all of their holdings on a daily basis.
Potential downsides of ETFs:
- Lack of control - there's nobody buying/selling for the fund on a day-to-day basis.
- Less options - while the selection of ETFs has improved in recent years, there are still some potential blind spots
That all makes sense, but what should I do?
The answer to that question very much depends on your unique situation, and there's no "rule of thumb" answer to give you.
This is where working with a fiduciary financial professional can make a huge difference in your life.
What is a fiduciary anyway? It means that your advisor has to act in your best interest, and they'll likely have to prove that to a compliance officer and/or a regulator such as FINRA or the SEC.
You want someone to act in your best interest, right?
A good financial professional will help you to assess your current situation, your goals, and help you to develop a roadmap of how to get there.
We give advice tailored to healthcare professionals that want to minimize taxes, invest wisely, and retire comfortably.
Next Steps:
Next up in the Investing 101 series - we'll talk about Target-Date Funds, which are usually an option inside your retirement plan at work.
If you'd like to learn more about the process we use to help potential clients make an education decision about our firm (or any other firm they're using/considering), just click below to see how we help our clients at Speer Street Financial.
Speer Street "Get to Know You" Process
A diversified portfolio does not assure a profit or protect against loss in a declining market.
Investing in mutual funds and exchange-traded funds are subject to risk and loss of principal. There is no assurance or certainty that any investment strategy will be successful in meeting its objectives.
Investors should consider the investment objectives, risks and charges and expenses of the funds carefully before investing. The prospectus contains this and other information about the funds. Contact William Hecklick at 412-600-6458 to obtain a prospectus, which should be read carefully before investing or sending money.