I like that word when it comes to investing.
It implies that there are several different ways of getting from here to there and none of them are right or wrong.
Today I want to talk about 3 investment vehicles:
- Mutual funds
- Index Funds
- Exchange traded funds
When you first start out investing and only have a small amount of money to invest every month, often mutual funds are a great way to go. You can set one up through your bank and make sure it’s protected from taxation through an RRSP or TFSA (see my past 2 posts).
You can ask your bank to automatically withdraw a set amount every month, and that money will be pooled with other investors to purchase a portfolio of stocks and bonds. By contributing the same amount every month you can harness the power of dollar cost averaging to maximize growth.
The benefit of a mutual fund is that it’s ideal for someone with a small amount to invest each month and no investment knowledge. For example, you can start a mutual fund at the Royal Bank with $500 and then set up a regular investing program for as little as $25 a month. You can then sleep well at night knowing there is a professional money manager watching the markets and making decisions.
So what’s not to love?
Fees! Mutual funds have a lot of fees associated with them. In fact Morningstar recently published a report stating that fees for Canadian equity (stocks) mutual funds were the highest among the 22 countries they surveyed. Read the article here.
These fees cut into the profits mutual funds return and hurt their performance in a big way. In fact the Motley Fool website reports 80% of managed mutual funds underperform the market.
So what are you to do?
In 1975 there was a Princeton grad named John Bogle who invented a type of mutual fund that would mirror the returns of the major markets while charging a fraction of the fees. The fund he started is now worth over $100 billion dollars! This type of fund is called an “index fund”.
To read about the difference between a mutual fund and an index fund, please click here.
There is one last type of fund that I want to touch on briefly. Exchange traded funds (ETF) have been growing in popularity over the past few years with financial institutions now offering a dizzying variety of them.
An ETF is like a mutual fund that is traded on the stock exchange. They have lower fees and can be traded much quicker than mutual funds.
If for example I wanted to sell some mutual funds, I would put in an order with my banker, he would sell the funds the next day and then I would wait for the funds to be deposited in my account. An ETF could be traded in minutes on the open market and then repurchased minutes later through a brokerage account.
Say for example, I wanted to take advantage of recent fluctuations in the price of gold. I could buy shares of iShares Gold Trust ETF and trade them several times throughout the day. Or maybe I just wanted a low-cost way of buying a basket of stocks in a particular industry, I could do that also with an ETF.
Click here to read about exchange traded funds.