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Over the last few years, more and more employer retirement plans have been adding exchange-traded funds (ETFs) to their investment options. That means most of us have, or will have, the choice of selecting mutual funds, ETFs, or a combination of the two as we invest for retirement through our 401(k)s.
Before you start investing in ETFs—whether in your 401(k) or in another brokerage account—you should read this breakdown of ETFs vs. mutual funds.
What Is a Mutual Fund?
When an investor buys a mutual fund, they contribute to a pool of money to be managed by a team of investment professionals. That team selects the mix of stocks, bonds, money market accounts, etc. in the mutual fund based on the fund’s specific objective or type. Dave’s own investing philosophy includes dividing your retirement investments equally between four major types of mutual funds:
- Growth and Income
- Aggressive Growth
Mutual funds spread your investment among many companies. This helps you avoid the risks that come with investing in single stocks while using the power of the stock market to grow your retirement fund.
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When you are choosing mutual funds, make sure to look for and invest in funds that have good track records.
Related: Ask Dave: How Do Mutual Funds Work?
What Is an ETF (Exchange-Traded Fund)?
Like mutual funds, ETFs invest in a variety of companies. ETFs generally track a market index, like the Dow Jones Industrial Average, by investing in most or all of the companies included on that index. This type of passive management keeps ETF fees low since there’s no team of managers selecting companies for the ETF to invest in.
ETFs are also designed to be bought and sold on the stock market exchanges during the trading day, allowing ETF investors to buy or sell in response to daily stock market swings. Mutual fund transactions, on the other hand, are completed after the markets close.
3 Things to Consider Before You Invest in an ETF
There are many ways you can invest your money—everything from a simple savings account to the most complicated financially engineered investment product. But, like a simple savings account, most of those options aren’t a good fit when it comes to investing for retirement.
Since ETFs and mutual funds seem so similar, it’s easy to think either, or both, would work well in your retirement plan. But Dave recommends mutual funds over ETFs for retirement investing. Here’s why:
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1. Mutual funds are made for long-term investing.
To build wealth for retirement, you need to select your investments for the long term. Mutual funds are a great way to do this. Once you choose your funds, you want to leave them alone for 10, 15, 20 years, or more—as long as they continue to perform well in their class.
ETFs, on the other hand, are not as suited for long-term investing. Since ETFs can be traded like stocks, investors can try to time the market and buy and sell ETFs for short-term gains and quick cash. But remember: To build wealth, you need to take a long-term approach. A Fidelity study recently showed the impact of selling when things are bad vs. staying invested for the long haul. On average, those who sold all stocks during the 2008 market turmoil and then reinvested gained 6.1%. But those who fought the urge to move things around and stayed put gained an average of 21.8%.(1)
2. ETFs are not fee-free.
ETFs can be paid for multiple ways: They can have operating costs—sometimes with transaction costs on top of that—or they can be in a fee-based account. Since most retirement investing is done through monthly contributions, those operating and transaction fees can quickly eat into your returns if you’re charged each time you add to your investment.
While ETFs generally carry lower fees than many mutual funds, when you invest in mutual funds through an experienced financial advisor, you also get personalized advice to help you make the most of your retirement investing dollars. That’s not the case if you’re trading ETFs in an account.
3. You can do better.
Mimicking a market index with an ETF sounds like a great idea. Over the long term—30 years or more—the S&P 500 averages 10–12% growth after all.(2) But if you like this idea of passive investing, an index mutual fund will allow you to "invest in" the index without additional brokerage fees or the temptation to day trade.
Even better, a good, growth stock mutual fund can beat the stock market’s average—that’s the job of the investing experts who manage a mutual funds’ investments.
It may seem like Dave knows it all when it comes to investing, but even he prefers to work with a financial advisor to help him with his investing decisions. And you should too. You can find a knowledgeable financial advisor through Dave’s nationwide network of investing professionals. Contact a SmartVestor Pro today!