ETFs and Mutual Funds for Dummies Like Me
Maybe it’s me but there’s a lot of information out there on ETF’s and Mutual Funds. Almost too much.
I might not be dumb, but I’m also not a financial advisor. I’m an average investor that’s hungry to learn more every day.
In my search for investments to plug into my portfolio, sometimes I needed help understanding what each option has to offer and why it might be good for me. My goal is to dumb it down and make it easier for you to understand.
When it comes to investing, there’s no shortage of options. Your choices on where to park your money can seem daunting.
There are different avenues for everyone. There are stocks, bonds, annuities, cryptocurrency, real estate, private equity, ETFs, and mutual funds.
It’s a lot to choose from. However, there are straightforward options that essentially make the decisions for you.
Two Simple Options
Two simple options for investments are ETFs and Mutual Funds. My goal here is to explain ETFs and Mutual Funds in a way that is easy for the average person to understand.
To give a basic understanding of what they are and how they can benefit you.
You don’t need to be a stock broker to invest in the market and feel good about it. You don’t even have to have in-depth knowledge to succeed.
Don’t let your lack of knowledge hold you back from growing wealth. These options are easy to understand and feel comfortable with, regardless of your knowledge base.
This article will cover ETFs and Mutual Funds. I’ll go over what they are, where you can find them, who should invest in them, why you’ll want to consider them and when you’ll want to start investing in them.
What is a Mutual Fund?
A mutual fund is a pooled collection of money that invests in stocks, bonds, commodities, or tracks a particular index. These funds can be actively or passively managed.
More often than not, they are actively managed. Mutual funds are operated by professional money managers.
These money managers allocate the funds’ assets to create gains for the investors. They’re generally aiming to beat the market.
Because they’re actively managed, these funds typically have higher fees than passively managed ETFs.
What is an ETF?
Like a mutual fund, an exchange-traded fund or ETF is a pooled investment that typically tracks a particular index or similar asset group.
For example, one of the most popular indexes to track is the S&P 500. The S&P 500 is a stock market index that tracks the performance of 500 of the largest companies listed on the stock exchange in the United States.
ETF vs Individual Stock
When you buy a stock, you’re investing in that one company. When you buy an ETF, your investment can be diversified over various asset classes, including stocks, bonds, commodities, domestic or international.
There can be hundreds of assets or stocks within one ETF. When you buy an ETF that tracks the S & P 500, you invest in the 500 US companies in that fund.
Because the fund mirrors an index, there’s much less need for constant control from a money manager. This results in lower expense ratios for the investor.
Where Can You Buy a Mutual Fund?
Mutual fund orders are executed daily after the markets close at 4pm. Everyone is buying at the same price that day. There are many different online brokers that you can use to purchase mutual funds.
A few options are Fidelity, Vanguard, Charles Schwab, and E-Trade. The list goes on.
Where Can You Buy an ETF?
Buying an ETF is no different than buying a stock. It’s a marketable security, which means it can be purchased and sold on exchanges throughout the day.
As with mutual funds, there are many online investment platforms where you can make your purchase.
This isn’t an endorsement or ad for them, but I use Fidelity and find it easy to manage. They’ve had helpful customer service every time I’ve needed to call.
Who Should Invest in Mutual Funds?
Investors trying to beat the market may consider investing in actively traded mutual funds.
However, money managers rarely accomplish the goal of beating the market or matching it over extended periods. You’re paying a higher fee for an actively managed fund for higher gains, which rarely accomplishes higher returns, especially over extended periods.
Who Should Invest in ETFs?
I believe that 97% of people should invest in low-cost index ETFs.
Not because I’m some wizard investor. Just the opposite, actually.
As I said earlier, I’m an average investor. I like to keep it simple, and index ETFs serve as a great, low-cost option for investing. Even now, as I learn more and expand my portfolio, ETFs are a foundation of my portfolio.
I invest in them every month and plan on continuing to do so for the remainder of my investing career.
I'm with the Oracle of Omaha
I’m really just stealing Warren Buffett’s advice.
He once said, “I think it’s the thing that makes the most sense practically of all time…consistently buy an S&P 500 low-cost index fund.”
How can you argue with that?! It’s freaking Warren Buffet’s advice. And he’s said it time and time again over the years.
Upon his passing, he also directed the trustee for his wife’s benefit to “put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.” His opinion had me investing in index ETFs, to begin with, and it’s a big part of why I still do it today.
Why Should you Invest in ETFs?
I’m not going to go over why you should or shouldn’t invest in mutual funds.
It’s not that you shouldn’t invest in mutual funds. However, I think low cost Index ETFs are the better option for “most” people. If you’re reading my blog, I’m guessing that you’re in the “most” category…along with myself.
Pros of ETFs
- Requires little knowledge of the market
- You don’t have to know anything about stocks, bonds, the market, or investing, in general, to invest in ETFs. You’re not researching the stocks, and you’re not selecting the stocks. That’s all done for you.
- Passive Strategy
- You don’t have to do anything. Consistently buy no matter where the market is and wait.
“Consistently” is the keyword there. I buy at the beginning of every month, and it doesn’t matter where the market is. I’m buying with dollar cost averaging in mind.
Buy it and forget about it. KISS – Keep It Simple Stupid.
- You don’t have to do anything. Consistently buy no matter where the market is and wait.
- Diversified Investment
- With VOO, you’re investing in the 500 largest US companies. With VTI, you’re betting on the entire US stock market. You’re basically betting on the US.
You’re not making a bet on a single stock. If the stock from one of those 500 companies goes down, it won’t significantly impact the ETF as a whole. Let’s say that one company goes up, just the same, it won’t have a massive impact on the ETF.
If the US economy tanks, that will most likely impact the ETF. However, we might have more significant problems at that point.
- With VOO, you’re investing in the 500 largest US companies. With VTI, you’re betting on the entire US stock market. You’re basically betting on the US.
- Low expense ratios
- This is the shining light of ETFs. So many actively managed funds have high expense ratios, which eats into your return. And they’re paying out lower returns over the long term!
Why would you pay more for something if you’re not guaranteed a better return? Or at least have a reasonable expectation of a better return.
- This is the shining light of ETFs. So many actively managed funds have high expense ratios, which eats into your return. And they’re paying out lower returns over the long term!
Cons of ETFs
- You Won’t Get Rich Quick
- Some people would say that the returns are good, and some would say they’re bad. That depends on the investor.
One thing is for sure, they won’t make you rich overnight. This isn’t a get-rich-quick scheme. It’s not supposed to be, though.
This investment vehicle is meant to benefit the consistent investor over the most extended time possible. As long as you understand this, I don’t see it as a con to this investment option.
- Some people would say that the returns are good, and some would say they’re bad. That depends on the investor.
- Less control and flexibility
- The stocks that encompass an ETF and their balanced weight within the fund are out of your control.
If you like to be an “active” investor, you won’t like this investment vehicle.
This isn’t even a con. It’s a huge benefit. I’m my worst enemy picking stocks as an average investor with intermediate market knowledge. I need to learn more to succeed at investing in individual stocks.
Trading isn’t my day job. I’ll leave it up to the experts.
- The stocks that encompass an ETF and their balanced weight within the fund are out of your control.
- Barrier to entry
- Some ETFs have minimum buy-ins. None of the ETFs listed above have minimums. You need enough to buy one share. So again, not really a con.
- Lack of downside protection
- You’re betting on the asset group or index that particular ETF is tracking. If that goes down, so does your portfolio.
When Should you Start Investing in ETFs or Mutual Funds?
Now! I don’t know how old you are, what your portfolio looks like or what your goals are, but you should start investing in ETFs now.
The sooner you get started, the better. However, there is always time. Just buy one share to break the seal.
Starting is always the hardest part. Setting up the account, linking the bank accounts, and making the trade. Once you do it, you recognize how easy it is.
Start with one share and be consistent from there.
What Do the Numbers Look Like?
Below are some elementary numbers on what investing consistently over time can do for you. Those who are in your 20’s, take note. The earlier you get started, the less you have to commit monthly to hit impressive wealth goals.
Man, I wish I would’ve listened to my mom when I was younger…insert Cher: If I could turn back time.
Those who have kids, send this to them. Teach them about paying themselves first. Start IRA and Roth IRA accounts for them when they’re young. Time is our most valuable asset in life, but time/compounding with investing is the world’s eighth wonder.
Start Investing at:
20: Invest into VOO at 8% return, $500 every month for the next 40 years
- The end balance at 60 years old is $1,047,302
30: Invest into VOO at 8% return, $750 every month for the next 30 years
- The end balance at 60 years old is $1,117,769
40: Invest into VOO at 8% return, $1,000 every month for the next 40 years
- The end balance at 60 years old is $589,020
Don’t have that money to invest? Check out my side hustle articles:
- My Top 10 Side Hustles
- What Do the Numbers Look Like with a Side Hustle?
Where to Get Started
Below are some funds where you might get started. Google each one and read up on them a bit.
I love these because of what they’re invested in and how low the expense ratios are. You’ll notice that I didn’t even leave the Vanguard umbrella. You don’t need to.
Keep It Simple Stupid. VOO or VTI are great options for the foundation of your stock portfolio, and then you can add from there. I invest in VOO:
- VOO – Vanguard 500 Index Fund ETF: seeks to track the S&P 500 and has an expense ratio of .03%.
- VTI – Vanguard Total Stock Market ETF: seeks to track the total US stock market and has an expense ratio of .03%.
- VIG – Vanguard Dividend Appreciation ETF: seeks to track the performance of common stocks with a record of increasing dividends over time and an expense ratio of .06%.
- VEU – Vanguard FTSE All-World ex-US ETF: seeks to track a market cap-weighted index of large and mid-cap non-US stocks and has an expense ratio of .07%
- VWO – Vanguard FTSE Emerging Markets ETF: seeks to track the performance of a benchmark index that measures the performance of stocks for companies in emerging market countries.
Slow and Steady Wins the Race
For those who have made it this far and say that you can’t get rich from investing in EFTs. I’m afraid I have to agree and disagree with you.
I can’t entirely agree with you because personal finance is personal. “Rich” is something different for everyone.
With this investing style, you can 100% retire at a standard retirement age.
I agree with you because this should not be your only investment vehicle. If you’re familiar with my blog, you know that I’m a huge proponent of real estate and private equity investing. It’s a mix of all these and other strategies that should be part of your portfolio.
However, to keep it dumbed down and simple, ETFs are a great place to start and can remain an essential piece of your investment puzzle.
It’s there. It’s easy to do. You have to take action!
“Now you know, and knowing is half the battle.”
