What is a 'Mutual Fund'?
A mutual fund is an investment vehicle made up of a pool of moneys collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and other assets. Mutual funds are operated by professional money managers. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.
The value of the mutual fund company depends on the performance of the securities it decides to buy. So when you buy a share of a mutual fund, you are actually buying the performance of its portfolio.
Mutual Fund Fees
In mutual funds, fees are classified into two categories: annual operating fees and shareholder fees. The annual fund operating fees are charged as an annual percentage of funds under management, usually ranging from 1-3%. The shareholder fees, which come in the form of commissions and redemption fees, are paid directly by shareholders when purchasing or selling the funds.
Annual operating fees are collectively as the expense ratio. A fund's expense ratio is the summation of its advisory fee or management fee and its administrative costs.
Diversification: Diversification, or the mixing of investments and assets within a portfolio to reduce risk, is one of the advantages to investing in mutual funds. Buying individual company stocks in retail and offsetting them with industrial sector stocks, for example, offers some diversification. But a truly diversified portfolio has securities with different capitalizations and industries, and bonds with varying maturities and issuers. Buying a mutual fund can achieve diversification cheaper and faster than through buying individual securities.
Exchange-Traded Fund (ETF)
An ETF, or exchange-traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.
Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated once at the end of every day like a mutual fund does.
ETF shareholders are entitled to a proportion of the profits, such as earned interest or dividends paid, and they may get a residual value in case the fund is liquidated. The ownership of the fund can easily be bought, sold or transferred in much the same way as shares of stock, since ETF shares are traded on public stock exchanges.
By owning an ETF, investors get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share (there are no minimum deposit requirements). Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you'd pay on any regular order.
There exists potential for favorable taxation on cash flows generated by the ETF, since capital gains from sales inside the fund are not passed through to shareholders as they commonly are with mutual funds.
An ETF of ETFs is an exchange-traded fund (ETF) that tracks other ETFs rather than an underlying stock, bond, or index. Like a fund of funds, this new approach provides investors with a method to invest in multiple different strategies with one product. It combines the cost and transparency advantages of the traditional ETF structure with the research and analysis of an actively managed fund. Many well-established providers like Vanguard and Direxion have hopped on the bandwagon through new product offerings that combine different asset classes or rotate between sectors.