Understanding Mutual Funds And ETFs

While we all wish we could be Warren Buffet, thegoes up 9% in a year, DIA will go up about 9%
truth is that most investors are best served justas well. In contrast, a blue chip mutual fund will
parking their money in a mutual fund or ETF.also invest in blue chip stocks, like the ones that
What is the difference between these two typesmake up the Dow Jones index, though it may
of investment options and which one is for you?choose to invest in only some of the stocks in
Both mutual funds and ETFs allow the investor tothe Dow Jones as well as other blue chip stocks
achieve diversification. Each invests in a basket ofthat are not in the Dow Jones. Thus, while the
stocks, so the investor generally does not haveDow Jones may go up 9% in a year, a blue chip
to worry that one individual stock will radicallymutual fund could have a vastly different return.
alter his or her returns. Both also give theIt might lose 2% or it might gain 15%; it just
investor the choice of investing in a certaindepends on the luck and the skill of the mutual
sector, if he thinks a sector will perform well. Forfund manager.
example, there are mutual funds and ETFs thatAs you can see, the key difference is how they
focus just on technology, and there are alsoare managed. But which one is better? Well, it
broader mutual funds and ETFs that focus on thedepends. Since there are more decisions and
market as a whole (if you want maximummore effort involved in a mutual fund, these
diversification).charge higher fees than ETFs. These fees may
The key difference between mutual funds andbe worth it though if the mutual fund can
ETFs are that mutual funds are actively managed,outperform its index peers. If the mutual fund has
whereas ETFs are passively managed. What doesreturns similar to an index or worse, than the ETF
this mean? Basically, mutual funds have awill be better.
manager that chooses which individual stocks toInvesting in ETFs are a little easier than a mutual
buy and sell. He will actively choose generallyfund. As you can see, with an ETF, you are at
50-300 stocks in which to invest. In contrast, anleast guaranteed to meet the index. With a
ETF will just invest in the stocks that correspondmutual fund, you could do better or you could do
to an index.much worse. One tip, more than any other, is to
For example, the ETF Diamonds (DIA) seeks tomake sure you do not pay too high of expense
track the Dow Jones index. The ETF'sfees with a mutual fund. If your mutual fund is
performance will almost exactly mirror how wellripping you off, you certainly will underperform
the Dow Jones index does. So if the Dow Jonesthe market!