Mutual Funds & ETFs

Used interchangeably, Index Funds, Mutual Funds, and ETFs (exchanged traded funds) can be confusing for the new investor. They all provide instant diversification, packaged in such a way that allows you to access multiple stocks at the same time. They can be actively managed or they can track a preconfigured index. Actively managed ETFs or Mutual Funds are a collection of stocks chosen by a portfolio manager, where as Index Funds and index tracking ETFs track a market index, such as the S&P 500 or the Nasdaq 100.

When you hear or read about “beating the market”, that refers to investors attempting to outperform the returns of the S&P 500 Index, which is often used as a benchmark for the market.

Index Funds and Mutual Funds

Mutual Funds pool money from investors to purchase stocks and bonds. Investors that buy into mutual funds don’t own the stock that the fund purchases, however they do share in the profits or losses from the fund’s holdings. They take the total value of the investments within the portfolio, then divide that by the outstanding shares. This is referred to as the NAV, or net asset value, which is the value assessed at the end of the trading day. They also generate capital gains distributions, which is your share of the funds gained by the sale of stocks within the fund. These gains are taxed, if held in a taxable brokerage account, which is why I always hold mutual funds in my Roth accounts.

Fidelity’s 500 Index Fund, FXAIX

Exchange Traded Funds (ETF)

An ETF, or exchange traded fund, is a basket of stocks and/or bonds that can be bought and sold during the trading day. Unlike the Mutual Fund, the value of the ETF is treated much like an individual stock, and fluctuates throughout the trading day. They also tend generate a lower amount of capital gain distributions compared to mutual funds, making them more tax efficient.

Because ETFs are more tax efficient, it’s preferable to hold them in a taxable account. Mutual Funds should be held in a tax advantaged account, such as an IRA.

Active vs Passive

Passively managed funds track an index, like the S&P 500, Nasdaq 100, or the World Market index (which is a basket of large and mid cap companies across 23 developed markets). Actively managed funds contain a basket of assets picked by a portfolio manager, who charges for his/her/their expertise in the form of the the fund’s expense ratio. Index Funds, or Mutual Funds that track an index, tend to have lower expense ratios since they passively follow an index. For example, Fidelity’s S&P 500 Index, FXAIX, charges an expense ratio of 0.015%, which is an annual expense of 15 cents for every $10000 held in the account. However, Vanguard’s Global Minimum Volatility Fund, VMVFX, charges an expense ratio of 0.21%, which is annual expense of $21 for every $10,000 you have invested. Meanwhile, the Northern Small Cap Value Fund, NOSGX, charges an expense ratio of 1%, which is an annual expense of $100 for every $10,000 you have invested. Keep in mind, these fees are charged whether the fund makes 8% in the year or loses 2%. Let’s say you just turned 30 and committed to investing $2000 a year until you’re 60. With a beginning balance was $500, you’d end up with $249,723.06. Now let’s take a look at how expense ratios can impact your gross return long term.

Exp RatioValue less Fees (net)Total Fee Paid
FXAIX0.015%$248,996.02$727.04
VMVFX0.21%$239,750.91$9,972.15
NOSGX1%$205,952.21$43,770.85
Mutual Fund Calculator from NerdWallet.com

What is the S&P 500? The S&P 500, or the Standard & Poor’s 500 Index, is an index of 500 publicly traded companies in the United States. It’s often utilized as an indicator for how well large capitalization companies (large caps) are performing and how the stock market is performing overall. Large Capitalization refers the a company’s market cap, or the total value of a company’s shares of stock. This is calculated by multiplying the current share price by the number of outstanding shares.

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