Most people know that if they invest, they’re going to be buying mainly stocks and bonds.
But how do investors go about buying them?
Sure, you can buy individual stocks and bonds, but that can get kind of frustrating - going through the same steps over and over to make sure you’re diversified:
Type in ticker
Select number of shares
Click buy
Click confirm
Repeat over and over until you’ve built your portfolio (and hopefully you didn’t make any mistakes)
Not to mention, most people don’t have enough cash to buy a bunch of different stocks - if you just wanted to buy Microsoft, Walmart, and McDonald’s (3 large US stocks), it would cost you around $800-900 (as of 2/16/24), and that’s just ONE SHARE OF EACH! If you wanted to own roughly the same allocation of each, you’d have to buy 3 shares of Microsoft, 4 shares of McDonald’s, and 7-8 shares of Walmart - and that would cost more like $3,500-4,000.
So what do we do instead? We use funds.
Now, there are two different main types of funds: Exchange Traded Funds (ETFs) and Mutual Funds.
They have a lot in common, so let’s start there.
They both:
Have managers who buy stocks and/or bonds pursuant to a stated investment objective
Have underlying fees associated with them (called an expense ratio - this is how the managers get paid)
Are typically available for anyone to buy (sometimes with minimums)
Can be actively managed or passively managed
Active management means the manager is buying and selling within the fund to try to outperform a market index (like the S&P 500). Ironically, these funds tend to underperform the market, in large part because they tend to have higher fees. They’re also less tax-efficient.
Passive management means the manager is tracking a market index (VOO and IVV are two funds that track the S&P 500). The goal is to have performance as close to the index as possible. They aren’t super exciting, but they have lower fees and tend to perform better than actively managed funds tracking the same index.
Now, what’s different?
Well, ETFs:
Can be bought and sold at any time when the market is open
Can typically only be bought or sold in whole numbers (i.e. 1 or more shares at a time)
Don’t generally have embedded transaction fees (but the brokerage on which you buy them may charge you transaction fees)
And Mutual Funds:
Only transact at market close each day (4 PM Eastern Time for US markets)
Can be bought or sold in dollar amounts instead of shares (i.e. you might buy $50 of a $100/share mutual fund, so you’d be buying 0.50 shares of that fund)
Have different share classes that impact the fees you pay
You might pay a transaction fee up front, or
You might pay a transaction fee when you sell, or
You might not pay any transaction fees at all
You likely have access to mutual funds within your 401(k), and if you work with an advisor, you may own a mix of mutual funds and ETFs. It’s important that you understand the fees associated with them. Only then can you understand whether the strategy is worth the fee.
If you don’t know the fees you’re paying, your advisor can tell you. If you’re not comfortable asking your advisor, I’d be happy to aid you in that analysis - although that might be a sign that you should look for a new advisor.
Conclusion
If you’re looking to start investing, you’re likely better off using ETFs and/or mutual funds than trying to build a diversified portfolio of stocks and bonds from scratch. The investing universe is vast, so don’t be afraid to reach out if you feel like you would benefit from some assistance.
As always, keep in mind that you don't have to go it alone. I’m Austin Preece, a financial planner in Eau Claire, Wisconsin, and I work virtually with people across the US. Check out my website to see what it's like to work with me and reach out if you have any questions.
If you found this post helpful, help spread the word! Share with friends and family that you think may benefit as well. But remember, this is solely for educational purposes - it's not advice.
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