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Mutual Funds Vs Index Funds Vs ETFs

Dec 21, 2022

Mutual Funds vs Index Funds vs ETFs

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Lori Gann Morris, CIMA®, AIF®, CeFT®, Co-Founder / Managing Partner

It’s common knowledge that investing in mutual funds, index funds, or exchange-traded funds (ETFs) can help build a diversified portfolio. These funds hold diverse baskets of securities, including stocks, bonds and other assets from real estate to derivatives. By investing your money in a variety of investments, you help minimize the risk that your investments will lose value all at once, and you broaden your opportunity for gains.

But how do you choose between these options? Each type of fund has its own advantages and drawbacks, and with planning you and your financial advisor can work to determine which is best for you.

What are mutual funds?

A mutual fund pools money from many investors and uses it to invest in a variety of securities. Mutual fund shares represent partial ownership of the fund and entitle investors to the income generated by that portion. These funds tend to have minimum investment amounts between $500 and $5,000.

Mutual funds are usually actively managed. Experienced professionals select and monitor the securities held in the fund, with the aim of maximizing return while ensuring their selections meet the goals laid out in the mutual fund’s prospectus. Active management can make mutual funds a relatively expensive choice compared to other fund options. Compare fund expenses by looking at a fund’s expense ratio, which compares total fund costs to total fund assets. The lower this percentage, the cheaper the fund is to own. On the other hand, higher expenses can eat into your long-term returns.

Unlike stocks, which trade throughout the day, mutual funds only trade once per day after the market closes. Prices are based on a fund’s current net asset value (NAV), calculated by adding the total value of the fund’s holdings and subtracting its liabilities.

In addition to stock and bond funds, money market and target-date funds (TDFs) are other common mutual fund options. Money market funds invest in short-term debt. They’re designed to provide higher returns than interest-bearing bank accounts, and are used by individuals and institutional investors to invest in shares of government bonds, corporate stock, bank debt, and more. TDFs are popular retirement investment vehicles. Individuals select a TDF with a particular target date, such as the year they wish to retire, and the fund gradually shifts to a more conservative asset allocation as that date approaches.

What are ETFs?

ETFs differ from mutual funds largely in the way investors purchase them. They are traded on the stock market throughout the day just like stocks, making them a more liquid option than mutual funds. There are no minimum investment amounts, and some brokers even allow you to buy fractional shares.

ETFs are usually passively managed, built to track a broad market benchmark. Passive management doesn’t require daily human touch, which often makes them a cheaper option than mutual funds. That said, some actively managed ETFs do exist, often with the goal to outperform a benchmark. Investors will likely pay more for active funds.

What are index funds?

An index fund can be a mutual fund or an ETF, but they are passively managed and built to track a market index, such as the S&P 500 or Russell 2000, for instance. Depending on the design of the index fund it may track all or a portion of the securities in a given index. As mentioned above, passively managed funds tend to be cheaper than active alternatives.

Contact us today to discuss your short- and long-term investment goals and we can help guide you toward the investment tools that are right for you.

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Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any securities or to advise on the use or suitability of The AMG Managed Portfolio Series, or any of the underlying securities in isolation. Information specific to the underlying securities making up the portfolios can be found in the Funds’ prospectuses. Please carefully read the prospectus before making an investment decision.

This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this article should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy.

Investing involves risk. Principal loss is possible. Investing in ETFs is subject to additional risks that do not apply to conventional mutual funds, including the risks that the market price of the shares may trade at a discount to its net asset value(“NAV), an active secondary market may not develop or be maintained, or trading may be halted by the exchange in which they trade, which may impact a fund’s ability to sell its shares. Shares of any ETF are bought and sold at Market Price (not NAV) and are not individually redeemed from the fund. Brokerage commissions will reduce returns. Market returns are based on the midpoint of the bid/ask spread at 4:00pm Eastern Time (when NAV is normally determined for most ETFs), and do not represent the returns you would receive if you traded shares at other times. Diversification is not a guarantee of performance and may not protect against loss of investment principal.