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Comparing Mutual Funds With Exchange-Traded Funds

Mutual Funds and ETFs (exchange-traded funds) may be attractive to investors because they commonly offer diversification and professional management for a comparatively low cost compared to some other types of investments. The range of types of funds available to investors allow access to a range of investment strategies and philosophies. Mutual funds and ETFs are similar in many ways, but it is important to note their differences as well.

An investment fund is a portfolio of investments that many investors put their money into together. This may decrease exposure to risk and can allow both beginners and more experience investors to tap into a diverse investment. Mutual funds and ETFs represent a range of investment styles and strategies.

Mutual funds date back as far in history as 1924. ETFs, however, have only been in existence since 1993. Despite being a more recent investment product, ETFs are gaining in popularity.

What Is The Difference: ETF and Mutual Fund

Perhaps the biggest difference between an exchange-traded fund and a mutual fund is in the way they are traded.

Mutual funds are purchased either from a broker or from the mutual fund company. The net asset value of the fund is calculated as the market closes each day, and all of the buy or sell orders that have been placed throughout the day will execute at this time.  

ETFs are traded through an exchange, as the name suggests. An ETF calculates its NAV at the end of the trading day similarly to a mutual fund, but investors  can purchase shares at market value, throughout the day.  This is an important distinction from a mutual fund.

Expenses

When it comes to fees, one of the biggest factors in comparing expense ratios is whether the investment is passively or actively managed. Similarly, both types of funds represent such a wide range of characteristics that it is impossible to say that one has a typically larger expense ratio than the other.

Rather, each type of fund has certain common fees that investors should keep an eye on. For example, ETF investors are sometimes responsible for brokerage fees, while mutual funds are may or may not have a sales charge associated with the purchase. Account fees, redemptions fees, commissions, and more may all be be part of the costs associated with a mutual fund. 

The fees and expense ratio of each individual fund will be located in the prospectus. While both mutual funds and ETFs may have y lower fees that other types of investments, small fees may have large compounding effects on the total investment return. This makes it important to analyze each investment to ascertain the total cost of owning it prior to making a purchase.

Similar But Not The Same

ETFs and mutual funds have some marked differences. It is important, as an investor, to understand the investments and financial products you purchase. At the same time, both ETFs and mutual funds are available to represent the full range of conservative to aggressive investment strategies. No matter your investment strategy, investing in a  mutual fund or an ETF  may provide a diverse portfolio.

Bonds: A Beginner's Guide to A Classic Investment

A bond is a way for an investor to loan money to a company or government. When you buy a bond, the company uses your money to invest in the company and pays you an interest rate. Most bonds pay interest annually or semiannually. When the bond matures the face value of the bond is paid to you as a return of principal. 

Depending on the length until the maturity date of the bond, an investment in bonds may be a short, medium, or long-term investment. Bonds can be for any length of time and may command a higher return with longer maturities.

A bond is a simple-to-understand investment that gets a little more complicated when you buy and sell bonds instead of holding them. The price of a bond is influenced by interest rates, meaning a bond’s par value can change from the time you buy it to the time you sell it. If the interest rate goes up the value of the bond tends to decrease. If the interest rates go down, then the price of your bond would tend to increase.

Types of Bonds

Some bonds have a greater potential yield than others. One bond may have less chance of being defaulted on than another bond. The first thing to understand about what makes bonds different from one another is who issued the bonds and what type they are.

  • US Treasury Securities- “Backed by the full faith and credit” of the United States, the United States Treasury would have to be in a state of major economic catastrophe for these bonds to be defaulted on. Prices rise and fall on the market, but there is very little chance the investment will lose significant value while you hold it.
  • US Savings Bonds- Also issued by the federal government. These are simple and straightforward. They can be purchased in small amounts, making it an accessible option for people who do not have a lot of money to invest.
  • Municipal Bonds- These are issued by non-federal government bodies such as states, cities, and counties. Many municipal bonds support specific projects, such as purchasing new fire department equipment or repairing roads.
  • Corporate Bonds- Are issued by all kinds of companies. Corporate bonds are segmented by the types of industry, according to the company that offers them. Being backed by a company instead of a government body means that there is a larger chance the bond could be defaulted on if the company goes under.
  • Bonds in International and Emerging Markets- These are bonds issued by governments or companies that are not in the United States. Although international and emerging markets can be used to diversify a portfolio, they carry a separate set of considerations than other types of domestic investments.

This is not an exhaustive list. There are many more kinds of bonds you can invest in, including some that are complicated to understand. Just like any other kind of investment, you must perform the due diligence required to make sure you’re investing in bonds that are right for you and your investment strategy.

A diverse portfolio holds many types of investments, and bonds tend to play a role of stability and income. That diversification continues to be important even as beginner investors gain experience and experiment with more aggressive investments. The conservative nature of bonds make them an investment worth considering for young and experienced investors alike.

How To Assess the Performance Of An Asset

Measuring the performance of an asset means looking at whether the investment is doing well and is worth keeping in your portfolio. The phrase is sometimes used when speaking about the performance of a company, while other times it might refer to the performance of the company’s stock price.

Company Performance

Different company metrics can shed light on how the company is performing in comparison to others in its industry. These tools include numbers like:

  • Cash conversion cycle- a metric that measures the time it takes a company to start with cash, produce inventory, sell the inventory, and hold cash again.
  • Return on assets ratio- a metric that measures the ratio between the amount of profit a company makes and the total number of assets the company holds.
  • Fixed asset turnover rate- a metric found by dividing the number of total sales by the total number of company property, plant, and equipment (fixed-asset investments). 

Assessing performance of a company could mean comparing these metrics against the average numbers for the industry, or it could mean noting whether the metrics are showing an improvement from a period of time. For example, a company that finds a way to sell their produce faster may improve their cash conversion cycle outlook.

Return on Equity

One potential way to assess the performance of an asset is to look at the returns earned since the asset was purchased. This can manifest in different ways, such as regular dividends or an increase in the value of the stock. An investor might be pleased with the performance of their asset if it performs as expected in accordance with his or her investment strategy.

Investing Is More Than Metrics

Two investors studying the metrics of the same company may disagree on whether or not the asset is performing well. That is because measuring the performance of an asset means more than consulting numbers. Assessing performance means understanding how the asset fits into your investment strategy, what role it plays in your portfolio, and whether or not it is performing as expected.

A company that focuses on shareholders could choose to release regular dividends instead of investing profit back into the company with the goal of growth. Another company could focus solely on investment and make no promise of dividends to their shareholders. These choices may influence whether or not an investor is satisfied with their asset performance.

The Role of Asset Allocation In A Healthy Portfolio

Asset allocation is a phrase that refers to how you allocate your funds into different classes of investments. It is a simple concept, but the way you allocate your assets may have big impact on the overall performance of your portfolio.

Investment Classes  

There are three basic type of public investments:

  • Equities or Stocks:

Equities or stocks are an investment class where the asset you own is a portion of the company itself. The price any given equity may change, although the “market” has gained 7% to 10% a year on average overall. (Past performance is not a guarantee of future performance.) Investors attempt to sell equities for a higher price than they paid for them, sometimes by holding the stock for a long time and sometimes by selling the stock quickly if the price rises.

  • Fixed-Income

Fixed-Income investments bring in income for the time that you hold them. An example of a fixed-income asset is a bond which pays the stated yield twice a year until it matures for the original face value. The value of bonds fluctuates and some bonds are more stable than others, offering investors a range of conservative to aggressive strategies.

  • Cash Equivalents 

Cash equivalents are assets that offer easy access. It is easy to purchase these investments, for example, savings accounts or a money market fund. Although cash equivalents usually offer a low interest rate, the reason to keep them is to have fast, easy access to money.

Asset Allocation Formulas

Many professionals who give advice on asset allocation claim to have a magic formula that anyone can follow in order to understand what their asset allocation should be. Commonly, these formulas begin with the age of the investor, which allows the formula to make assumptions about how aggressive the investor can “afford” to be.

The idea is that a younger investor has potentially many years ahead of them to earn money compared to an investor closer to retirement age. Therefore, according to the theory, a young investor can take a more aggressive investment stance while an older investor might want to be more conservative. The more aggressive the investment strategy, the higher the potential to lose money. The formula hinges on the assumption that younger people can more easily recover from a loss than older people.

However, generalized formulas do not take unique situations into perspective. In fact, it is fairly easy to imagine, for example, a young investor requiring a more accessible and conservative portfolio compared to an older investor who may not have such a great need for access to cash. The truth is that deciding your asset allocation means understanding your specific needs, goals, objectives and financial situation in order to determine the best asset allocation for you. 

Keep Asset Allocation at the Forefront

To determine your asset allocation, you will need to examine your financial situation carefully. Consider how much of your portfolio you may need to be able to access quickly, what kind of risk you are comfortable with and what your long- and short-term financial goals are. These are the core questions to determine your asset allocation, which is crucial to any investment strategy.

How Is Private Equity Different From Public Equity?

Investing in equity means owning a portion of a company. Private equity versus public equity refers to how the shares are traded and who may be eligible to purchase them. Many investors are more familiar with public equity, which is traded on a public exchange. Private equity cannot be sold on an exchange. In many cases, investors must meet certain qualifications in order to purchase it. 

All equity is not created equally. There are major differences in the way private and public equities are purchased, held, and sold. They require different investment strategies and play separate roles in a balanced portfolio.

Public Equity

If a company decides to "go public," they may hire an underwriter to evaluate the offering and to set the expected price of the stock.  This stock will be offered to investors once it is priced.  After it is priced, it is then listed on an exchange so that anyone may purchase the shares. The offering is priced based upon the value of the offering and how much interest the offering is likely to attract from both individual and institutional investors. After the stock officially opens on an exchange, the shares are free to trade and the price will fluctuate based on many factors, including supply and demand.

When corporations are publicly traded, they are required to make quarterly filings with the Securities and Exchange Commission. The company must publicly disclose its financial condition. If a company fails to accurately report their financial information, they could be misleading their shareholders, which the SEC takes very seriously. 

Private Equity

Private equity is a much more restrictive type of investment. When a company wants to raise money but cannot or does not want to go public, they may choose to offer private equity to qualified investors which is strictly defined by the SEC For example, your friend from college launched a start-up and they are raising funds. You could invest some of your money into their business in exchange for a specified portion of the ownership. If the start-up fails, you may lose all of the money you invested. But if the company is successful, your investment may be worth more than the amount you originally invested.

Private companies do not have to release their financial information to the public, only to their investors. 

Making Shareholders Happy

Another difference between private and public equity is the amount of people the leadership of the corporation needs to please. A private company usually has a smaller number of people who are shareholders and tend to have a desire to see the company grow exponentially. Private equity investors are sometimes less interested in an immediate return on their investment purchase and more interested in seeing it grow over time.

Public companies, on the other hand, usually have a much larger pool of shareholders who may put pressure on leadership to see a current return on their investment. This often means making decisions between what will be best for the investors and what will be best for the company. For example, a company might decide to release a dividend to please the shareholders instead of investing that money back into innovation which could make the company more profitable in the future.

Public Vs. Private Equity

It is a common misconception to assume that all large companies are publicly-traded while all small companies are private. A corporation can also decide that it no longer wishes to be publicly traded. In other cases, companies become private after being acquired.

Public equity is more liquid than private equity and is available to anyone who wants to purchase shares. The two types of assets are managed with different strategies and target different investor goals and objectives.