One exciting thing about investing is that you have a lot of options if you’re trying to decide where to put your money. But sometimes, when different investment products start to sound like one another, it can be hard to keep them straight.
You don’t have to look far for a good example of this. Consider: exchange-traded funds (ETFs), mutual funds, index funds and money market mutual funds. Oof – even if you’re a more seasoned investor, that list can seem like a confusing word salad.
Don’t worry, we’ll go over these different investment funds below. We’ll also compare ETFs to each of those mutual funds to help you better understand some of their similarities and differences. That way, you can decide which option may be a good fit for your investment style and goals. (We hope you like charts because we have a few coming your way.)
Let’s start with the basics to make sure you have a general understanding of how these investments work.
What are ETFs? ETFs have become popular over the years because they can help investors build a diversified portfolio at a relatively low cost. As you can probably tell from the name itself, ETFs are a type of investment fund that can be traded on an exchange, like stocks. A single ETF can hold a variety of assets, such as bonds (bond ETF), stocks (stock ETF) and commodities (commodity ETF).
So for example, when you invest in a stock ETF, you’re not investing in just a single stock but rather, a number of different stocks all at once. ETFs can be structured in many different ways. They can even be built to track certain indices, such as the S&P 500.
Keep in mind that different types of investments come with different tax considerations.
Because of their range of assets, ETFs have a certain degree of diversification already built in. This makes them a popular option for investors looking to diversify their investments. (But remember: Diversification doesn’t guarantee a profit nor can it protect against loss.)
Now, believe us, we could talk about ETFs all day, but we have a few more investment options to go over. So check out our article, “What Is an ETF?” if you want to learn more.
What are mutual funds? Like ETFs, mutual funds allows you and other investors to pool your money together and invest in a collection of stocks, bonds and other assets. This collection is often referred to as the fund’s “portfolio.” When you invest in a mutual fund, you’re essentially buying a share (or shares) of the fund. And when the fund or portfolio generates income, you get a portion of that.
Because you’re pooling your money with other people, mutual funds can give the average investor a cost-effective way to invest in a professionally managed fund.
Unlike other popular investments (like stocks and ETFs), mutual funds are not traded on an exchange. Instead, you buy shares directly through the mutual fund company (or a broker for the fund). Shares are bought and sold once per day when the market closes. And the share prices are based on the fund’s net asset value, which is calculated at the end of each trading day.
To learn more about mutual funds, you can visit Investor.gov.
Now that you have an overview of ETFs and mutual funds, we thought it would be helpful to compare them side-by-side. (Who doesn’t love a good chart?)
A quick word on taxes: Keep in mind that different types of investments come with different tax considerations. It’s a good idea to consult a professional tax advisor if you have any questions about how your investments may be taxed.
What are index funds? Index funds are a type of mutual fund or ETF. So when you’re shopping for index funds, you may come across index mutual funds or index ETFs (which can get confusing, we know!). No matter the structure, an important thing to know about index funds is that they follow a specific investment strategy. And once again, their name gives it away: Index funds are built to mirror or track a particular market index, like the S&P 500. (Note: You can’t invest directly in a market index, and that’s why it’s usually done through an index fund.)
Say you were to invest in a S&P 500 index fund – the fund’s portfolio would include stocks (either all or a representative sample) from that index. Because index funds aren’t necessarily trying to beat the performance of the market – but rather, to match it – they are commonly considered a type of passive investing.
For a closer look at index funds, visit Investor.gov.
Get excited. We have another chart. Let’s compare ETFs to index mutual funds (since index ETFs are just another type of, well, ETFs.)
Money Market Mutual Funds. A money market mutual fund, or simply “money market fund,” is a type of fixed income mutual fund. In other words, these funds typically invest in high quality (translation: low risk of default) debt securities with short maturity dates. This may include things like certificates of deposit (CDs), U.S. Treasury notes, municipal bonds and corporate commercial papers.
Because of the type of investments they hold, money market mutual funds are generally considered to be less susceptible to market volatility than other types of investment options such as stocks. Investors look to money market mutual funds when they want to park their money in an investment vehicle that’s relatively stable and where they’re able to generally earn higher interest rates than a traditional savings account.
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