Index Funds and ETFs

Also referred to as a buy and hold strategy, passive investing methods seek to minimize buying and selling to reach a goal of building wealth gradually over time. Unlike active investing, passive strategies can involve a lower cost structure for investors since it typically aligns itself with a lower management expense ratio. This lower expense ratio normally comes from a lower amount of maintenance involved and therefore lower transaction fees and commissions. Because active management typically comes with a higher expense ratio, they are often at a disadvantage to index funds in terms of needing to net higher returns to make up for their higher fee structure that can end up diminishing returns for investors. However, while active investing can be a useful tool for those seeking to minimize downswings in the market; oftentimes, index funds with their lower expense ratios can lead to better performance over time.

Index investing does not seek to outperform the markets and having full exposure to the underlying markets means that an investor participates in any upswings and more importantly, downswings as well. For another, portfolio diversification includes holding a number of securities across multiple asset classes and geographical markets. Although index investing will often include a large number of securities, investing in a single index will not provide for a full portfolio diversification. Normally this diversification can be achieved through a combination of different index funds and/or actively managed funds.

Although what is right for you will depend on your investment plan and strategy, both index mutual funds and index ETFs are designed to track indexes. However, they differ not only on how they are structured, but by how they can be bought and sold as well. ETFs trade like stocks in that they can be bought or sold throughout the day on an exchange. Meanwhile, while shares of mutual funds can be redeemed, they are priced at the end of the trading day after the order has been sent in. This means that if you were to sell a mutual fund share, you will capture the price calculated at the end of the trading day once their net asset value (NAV) has been calculated for that day. Contrastingly, since an ETF can be bought throughout the day, its price relies on supply and demand rather than only the NAV of the fund. Because of this difference, there can be associated costs involved. An ETF can run the risk of trading for far below their NAV or it could be trading far above its NAV outcompeting an index mutual fund. Since the NAV of a mutual fund is calculated at the end of the trading day, an investor looking to redeem their shares may run the risk of getting a lower than they anticipated. There are additional differences that should also be taken into consideration when buying either an ETF or a mutual fund, such as trading commissions and any possible sales charges.

All team members at Florida Financial Advisors are knowledgeable on the many different types of index funds available and can help guide you to make sure one of them is the right choice for you. Contact us today for a free consultation.