Everyone is always telling you to simplify this, simplify that. Your closet. Your workout routine. Your financial life.
Great advice, but how do you actually do that?
One thing to do is cut through the noise. And few things are more blaringly confusing than looking at a line-up of investments when you open an individual retirement account (IRA) or sign on to your company’s 401(k) plan.
So many funds, so many names, so many decisions. You probably already know more than you think you do.
Take mutual funds. This is a collection of securities: usually stocks, sometimes bonds. They’re professionally managed by a portfolio manager, so they come with fees. You probably also know what an index fund is: a variation of a mutual fund that holds a basket of stocks that tries to mirror or track the performance of an index. The best-known indexes are the S&P 500 and the Dow Jones Industrial Average.
An exchange-traded fund, or ETF, is a cousin, if not a sibling of these funds, says Kip Meadows, CEO and founder of Nottingham, a Rocky Mount, North Carolina fund administration firm. An ETF’s composition — a diversified collection of securities — is similar to that of a mutual fund.
But this type of fund has a few differences, and some features make it especially good for a new investor.
The main difference between these funds and mutual funds is that ETFs trade on an exchange all day, just the way an individual stock does. In other words, you can buy shares of an ETF in the morning and sell it in the same afternoon, says Eric Ervin, CEO of Blockforce Capital, a San Diego-based asset manager.
Investments are always somewhat complicated. There’s a lot of under-the-hood construction and regulation you don’t see unless you really go looking for it. But you don’t need to. You don’t have to build Big Ben when you just want to know the time, Meadows says.
The first ETFs were based on an index. These days, you’ll see a wide variety, some based on different countries and different sectors, such as oil and energy or technology. That’s helpful if you have specific views on how you’d like to invest your money, Ervin says.
Mutual fund prices fluctuate throughout the day, but you can only buy them at the close of business. Say you want to buy a mutual fund comprised of tech stocks such as Apple. At 10 in the morning, you see that the price is pretty good. But you will have to wait till the market closes to buy it, and it can be tricky to nail down the price you want.
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An ETF trades throughout the day. Like the price that morning? You can buy it right away, which is great for instant-gratification types.
Mutual funds must post their holdings every quarter, and they can rebalance and change their composition frequently, without letting you know every single movement. Not so with ETFs.
“The day that change is made, you know the next day,” Ervin said. “We know every single day what the holdings in that ETF are.”
If you’re mainly investing through a workplace retirement plan, such as a 401(k), you may not find any ETFs available.
If you don’t have the option of choosing an ETF, don’t worry. “Both ETFs and mutual funds have a lot of value,” Meadows said. “Our economy is focused on innovation, and more innovation will take place in ETFs over the next 10 to 15 years.”
As more 401(k) participants ask for ETFs and employers start putting them into workplace plans, Meadows says you will probably find them more available.
Meanwhile, they are a perfect choice for an IRA, whether a traditional or Roth.
Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.
