By Cassandra Ying
So you’ve probably heard of stocks and bonds, the two main types of investments you can make. Both of these are individual securities, granting the investor the ability to select individual investments. However, many people struggle with the responsibility of researching and managing a portfolio. As a result, they turn to mutual funds and exchange-traded funds (ETFs).
What Are They?
Both types of funds are essentially a collection of investments. They collect money from several investors and purchase a wider selection of individual securities. Similar to mutual funds, exchange-traded funds give the investor two key advantages: diversification, which reduces risk, and professional help. An ETF is essentially a traded portfolio. By the same token, funds don’t offer the investor the same freedom in selecting what goes in and out of a portfolio. Sometimes, funds are handled solely by the manager, while other times, they may be governed by rules.
Differences Between The Funds
At the most basic level, the key difference between mutual funds and exchange-traded funds lies in their purchasing and trading. Mutual fund portfolios can only be changed at the end of each trading day, whereas ETFs can be traded throughout the day. Consequently, ETFs can be sold short, meaning it can be bet against (see this article for more on shorting). This is an attribute that attracts short-term investors. Another virtue of ETFs is their significantly lower investment minimum, which is the minimum amount that must be invested in the ETF to hold it. That enables more investors to join in. Mutual funds interest investors who have more to invest; oftentimes, this translates to people with retirement plans. A mutual fund’s higher investment minimum stems directly from the need to compensate management. Typically, mutual funds, which are managed actively, have more potential capital gains, or profit, relative to that of ETFs, which are managed passively. Passive management involves following a specific market index instead of aiming to outperform it, while, in active management, all portfolio decisions are made by a manager or a team of managers whose goal is to maximize profit by using their own judgement.
A market index is a widely followed, often hypothetical, portfolio or collection of investments that intends to represent the market as a whole or a segment of it. For example, the S&P 500 is the go-to index for viewing how to market as a whole is doing. Another example is the NASDAQ, which is the index representing the tech sector. One ETF that tracks the S&P 500 is the SPDR S&P 500 ETF. Another ETF, Invesco QQQ Trust, tracks the NASDAQ index.
There are many types of ETFs, such as US market index ETFs, foreign market index ETFs, currency ETFs, bond ETFs, industry ETFs, commodity ETFs, and inverse ETFs.
ETFs have several unique benefits over mutual funds and individual securities. They provide a comfortable middle ground for the common investor: lower investment minimums than mutual funds, more diversification than stocks and bonds, and limited control in trade pricing.
With a decent amount of money, any investor can join in. They’re purchased through a broker or a brokerage account on E*Trade, Charles Schwab, or Fidelity. As for choosing an ETF, SPY, IWM, QQQ, DIA, OIH, USO, and GLD are among the most popular. Narrowing down your options requires further research on the assets included, pricing, taxing, and historical record.
Impact on Markets
With their sudden rise in popularity comes an increase in newly established, not yet well-known ETFs. Since ETFs mirror a particular market index, experts have voiced concerns over possible impacts on the market, such as overvaluation, which is an overpriced stock, and the creation of bubbles, which is the result of overvaluation and a subsequent decrease in demand.
AI’s Potential Impact
Artificial intelligence has long been on the threshold of further developing many industries, funds being one of them. By acting as fund managers, machines have carved out a sizable portion of the industry. AI has already gone beyond simply analyzing portfolios; with adequate data, technology can provide investment recommendations and even conduct the same actions as traditional fund managers do. Nevertheless, AI has its limitations: for all the trends and opportunities AI picks up, humans aren’t completely sure why the machine has identified a pattern. But make sure to keep an eye out, for AI still offers considerable potential in the field of funds.