Just a quick obligatory disclaimer. I am not a licensed professional. This post is for reference and entertainment. I am not telling you what to do.
Investing is made out to be a complicated topic. It can be if you don’t know how to cut through all of the jargon. One decision you shouldn’t take lightly is whether you want to actively invest or passively invest.
Active and passive investing are terms you will hear when discussing mutual funds and index funds. Here is something worth knowing. All index funds are mutual funds but not all mutual funds are index funds. Confused yet? Great.
Throughout this post I’ll break down the difference between the two funds, what a fund is, reasons financial advisors can be helpful, and why the fees may not be worth it. Dive with me, into the pool of funds.
What is a Fund
A fund is a collection of money saved for the management of another purpose. In the context of an emergency fund, the collection of money is piled up for future disasters.
In investing, however, money is collected by many people and used to purchase large collections of similar securities (think a specific industry of stock, or bonds).
When discussing diversification, funds are arguably the best way to do this. Diversification is when you spread your investments around instead of putting all of your eggs into one stock. This strategy greatly reduces the risk of tremendous loss.
Mutual VS Index
Mutual funds and indexes are similar in that they contain a large number of like assets. They are different from each other in a few significant ways.
Mutual funds are actively managed, while index funds are passively managed.
Mutual Funds
Look to outperform the benchmark they compare themselves to
Have a manager who picks investments
Cost more in fees
Index Funds
Aim to match the returns of the market
Cost less in fees than mutual funds
Have companies that are switched out every quarter so very little oversight is needed.
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Here is what the above information means. Index Funds are cheaper than mutual funds because no manager needs to get paid to manage it. These fees or lack of fees come in the form of expense ratios and loads.
You could find a share of an Index Fund with an expense ratio of 0.04% whereas a mutual fund may have an expense ratio of 0.6%. The expense ratio is the percentage of the total investment value in your possession that gets paid to the fund for maintenance. If you have $10,000 of investments with an expense ratio of 0.6%, you’ll pay $60 per year to the fund.
Fund managers have a goal to beat the market. This means year after year, they need to get returns greater than the index they are comparing themselves to for the fee to be worth. Here are the odds.
A study performed by S&P Global stated the following.
[The study] found that 92% of active large-cap fund managers underperformed the S&P 500 over the last 15 years as of the end of June. Even over the past year, less than 40% could outperform.
Many investment professionals can take a guess and beat the market for one year. The longer period they try to outperform the market, the less successful fund managers are.
My Thoughts
More often than not, an advisor wants to make a good living by recommending certain investments. There are many things they can sell, but more often they will sell something that is a combination of safe for the investor and profitable for the advisor. Part of the expense ratio and load fees go toward the advisor who sold the investment.
Advisors can be good for a few reasons.
Advisors are very knowledgeable and can teach you about what you are investing in. It is important to understand what you are spending your money on. Looking for a fiduciary is a good idea.
Fear and greed can cause investors to act irrationally. Advisors can act as accountability partners and “advise” you not to jump out of the market when things look like a crash or correction.
Financial advisors have the time to analyze what you can’t. It’s part of their job. They can send you research on certain trends and insights.
Here are some benefits of investing on your own.
Generally speaking, if you go the route of passive investing - which is recommended for investors going their way - passive investing is cheaper. Like one-tenth of the cost in terms of expense ratios.
Index funds like the S&P 500 or the Russel 3000 outperform comparative mutual funds frequently.
All of this means you may be paying less for better returns.
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I hope this was informative. If so please subscribe and send this to someone you love. Or someone you hate, if the spirit moves you.
Thanks,
Dylan
