Mutual Funds, Index Funds or ETFs, Which is Best?

Are you feeling lost in the sea of investment options?

Want to know the differences between individual stocks, mutual funds, index funds, and ETFs?

I've got you covered in this episode.

We're breaking down the pros and cons of individual stocks, mutual funds, index funds, and ETFs. You'll discover the benefits of professionally managed mutual funds, the lower fee structure of index funds, and the flexibility of ETFs.

I also delve into determining the most suitable individuals for various investment options, providing you with the information to make well-informed decisions about your financial future.

By understanding these key factors, you can align your investment choices with your financial goals and needs. If you want to dive deeper into this topic, be sure to tune in to the full episode.

IN TODAY’S EPISODE, I DISCUSS: 

• Choosing between mutual funds, index funds, or etfs for your investment portfolio
• Pros and cons of each investment option
• How to align investment choices with financial goals

RECOMMENDED EPISODES FOR YOU 
If you liked this episode, you'll love these ones:

• Q&A - Should I Invest in a Roth or Traditional IRA
• Which is Better High Yield Savings Accounts or CDs?
• Annuities...Investment, Insurance or Scam
• Using Target Date Index Funds to Build Wealth

TAKE THE FINANCIAL FREEDOM QUIZ:
Take this free quiz to see where you are on the path to financial freedom and what your next steps are to move you to a new financial destiny at http://www.YourFinancialFreedomQuiz.com 

OTHER RESOURCES:
7-Day Money Plan Workshop: https://www.TheMoneyPlanWorkshop.com
Affluent Entrepreneurs Private Facebook Group https://www.melabraham.com/group/

CONNECT WITH ME:
Website: MelAbraham.com
YouTube: MelAbraham.com/tube/
Instagram (@melabraham9): MelAbraham.com/ig/
Facebook Group: MelAbraham.com/group/
TikTok: https://www.tiktok.com/@melhabraham

GET MY BOOK:
“The Entrepreneur's Solution The Modern Millionaire's Path to More Profit, Fans, & Freedom” – melabraham.com/book/

Transcript

1:56

So you have some extra cash you're trying to invest, and you say, where do I invest it? Should I buy individual stocks? Should I buy a mutual fund or a couple of mutual funds or maybe some index funds or etfs? Hey, what the heck are all those things anyways? Mutual funds, index funds, etfs, what are the differences? I get it. It's confusing, and it can be confusing. But here's the deal. In this episode of the affluent entrepreneurship, we're going to break it all down for you because I think that you need to understand the differences so you see which one fits for you, fits for your circumstances and puts you on the road to financial freedom. Let's break it down for you. This is the absolute entrepreneur show for entrepreneurs that want to operate at a high level and achieve financial liberation. I'm your host, Mel Abraham, and I'll be sharing with you what it takes to create success beyond wealth so you can have a richer, more fulfilling lifestyle. In this show, you'll learn how business and money intersect so you can scale your business, scale your money, and scale your life while creating a deeper impact and living with complete freedom, because that's what it really means to be an athlete entrepreneur. All right, you've got some cash in your hands. It's burning. It's burning. It's burn. You want to put it to work for you, you sit back and say, I know that I need to invest, but where do I invest? Should I buy individual stocks? Should I buy these things that they talk about? Mutual funds, index funds and etfs, what the heck are they? Which one works for me? What are the pros? What are the cons? I'm breaking it all down for you right here. We're going to break it down. I'm going to give you the pros and cons of each and who it's most suitable for. So you'll be prepared to make the right decision for your circumstances at the end of this video. So stay with me throughout the whole thing. So let's just talk about this whole idea of individual stocks, because this is the way that most investors historically, over the years have done. It is I'm going to pick and choose different companies for those that are new to this reality is that when you buy an individual stock, when you buy an individual stock, what you're really doing is buying an ownership interest in a company. In other words, if I buy a share of Disney, I actually own Disney, but I don't own enough of it that I can have a say or I can get into the parks free or any of that stuff because there's so many millions of shares outstanding. But legally, you are an owner of a company that's publicly traded. And so that's what a share of stock is. The problem is that if I buy with individual stocks, in fact, let me bring a picture up so you can see what that looks like. Okay? Is that if I buy individual stocks, then I'm getting these certificates of these different companies. It could be, you know, Exxon, Boeing, B of A, all of them. You can buy interest in each of them. The challenges, they all cost money. They all cost money. Tesla is at $218 a share right now. It was at 262 weeks ago. Meta, Facebook is almost at $400 a share. They cost money. So if you have limited funds, say you only have $2,000 to invest, and you have Facebook or meta, that's at $400, you can buy like four shares, five shares, that's it. Okay? So you look at it and go, gosh, that doesn't give me much. And what it does is when you do that, you're putting all your eggs in one basket. If meta goes down, and that's all you have is five shares of meta, and say it goes from, it's at 376, or some call it 400, and say it goes from 400 to 300, you just lost 25% of your money. And so one of the challenges with individual stock investing is the fact that you're not diversified and you're putting all your eggs in one basket. Now, if you have a lot of money, you have millions, and you can buy shares in all the different companies and have a diversified portfolio, more power to you. But most people don't, especially when you're first starting out or even on the growth. And even if you did, is it advised to do so? Probably not, unless you're going to be analyzing the companies and doing the things that you need to do to make sure that you're investing in the right companies for the right reasons at the right time. Okay? So instead of doing that, because if we're not careful with that, what that leads to is that you're taking on more risk and you're putting more money up. And the industry figured this out and said, how do we give people, more people access to these companies and diversification and a little more safety and that type of thing? So they created these things called, initially they created things called mutual funds, and now we have index funds and etfs. We'll talk about the differences between all of them. And what they do here is then they turn around and say, hey, we're going to take the money from a bunch of investors, and we're going to acquire the stocks in these companies. We're going to put it in a basket, and you will buy a piece of our basket, and indirectly you will own a piece of all these companies. So it leads to you being able to get in the game for less money with more diversification, which means less risk. Okay, so that's how this game is played. This is why it was created, is to give you more access and less risk, even if you have a lower cash pool to work with. So that means that. Okay, fine, Mel, should I get mutual funds? Should I get index funds, etfs? What's the difference? Or does it matter? It does matter, and there is a difference. So let's break it down for you. Let's take a look at what the differences are with this. And let's start with mutual funds, because that's really where this whole thing kind of came from and where it started from. Okay. What is a mutual fund? Well, a mutual fund is where they actually pool the money of the investors, of people like you and I. And they take that and they create that. Professional managers will go in and they'll create a portfolio of stocks based upon the investing objectives. So every mutual fund is going to have an investment objective. It could be growth, it could be cash flow, it could be dividends, it could be a combination. It could be value. It could be sector based, it could be industry based. So they decide. These fund managers will then decide, and they'll take the pool of cash that comes in and they will create the portfolio and they will manage the portfolio. And they can buy stocks, bonds and other securities, and they'll put it in the portfolio. So it gives you access to it. So what are the pros and cons of this? Well, here's the first thing is that the pros are that one. It's professionally managed. At least that's what they say. Here's the thing, and I get it. It is professionally managed. You've got someone overlooking these companies, looking at what they own, making changes, making adjustments as they see fit, based upon the strategy and the objective of the fund. However, one of the things that you need to be aware of is over the long term, there are statistics out there that show long term, most actively managed funds do not outperform the market. And if they don't outperform the market, why are we paying the fees and the expenses to have someone professionally managed if they're going to underperform the market now doesn't mean that over a handful of years they're not outperforming the market. They are. They can. But can they do it over a decade or two decades? And you can bet on it and work from there. And statistics have shown not necessarily so. The other pro on this is that you actually have access to a diversified portfolio. So you're able to get into a group of companies that you wouldn't be able to otherwise do because you didn't have the cash or the volume, the size of the cash that you need to do it. Accessibility is good because the minimum investment to get in is lower. So even though some of the stocks that they hold might be 400 $500 stocks, even if you have 2000, you're buying a fraction of it because you're buying an interest in the mutual fund. Now, like everything, there's some cons because it's actively managed. You got these managers saying, hey, give me a piece of the pie. There are higher fees, there are fees involved with that. There are expenses involved inside the fund that are there, and some of them you don't even see. And I'm going to do a whole nother video and episode strictly on some of the fees that could eat away at your returns that you might not even be aware of, because a lot of people say it's the advisor fee, but that's one piece, there's plenty of other ones. And you'll see why index funds and etfs are better for it. But what we want to do is be aware of the fact that there are higher fees here because there's people that need to be paid to do the analysis, to manage the fund, to do the things that they don't have to worry about in index funds and etfs. The other thing that happens with mutual funds is that there's limited trading with them. And what I mean by this is that when you put an order in to buy or sell a mutual fund, you could put it in

at 10: 12:04

00 in the morning. It will not get executed until the end of the day. So you really don't know what price you're buying or selling at until the day is over. That can be a challenge, because if you've ever watched the stock market during the day, it can go all over the place, it can run like crazy. So you buy because you want something in the morning, because of where it's at, and then by the time it executes, at the end of the day, it was nowhere close to where you wanted to buy. And now you're in a different situation. So you've got limited trading. And the other thing that comes into play here is this idea of you have a higher potential for tax issues. The reason for that is these active managers are constantly buying and selling the stocks inside the mutual fund. And unless you hold that mutual fund in a Roth or an IRA, something that's tax advantaged every time they do a buy and a sale, if there's a gain on it, that gain is coming to you and you're going to have to pay tax on it. And worst case, you might not even have gotten cash from it to pay the tax. So you'll get this 1099 at the end of the year that has these gains on it that you have to pay tax on so they can be tax inefficient if you're not careful. I have one like that right now. And the funny thing is. Well, it's not funny when I have to pay for it, but the fact of the matter is that they bill themselves as tax efficient and it's nowhere close to tax efficient. All right, so who are these for? They're most suitable for those that sit back and say, I just want something that's professionally managed. I don't care. Okay. I'm not that concerned about fees and I'm not that concerned about tax inefficiencies. Just give me something that's professionally managed and I'll take it from there. Okay. Now I want to just hit a little bit deeper on this idea of fees because it is important when you start to look and say, well, I like professionally managed this and that. There are primarily three different classes of shares in mutual funds that you could get. Class A, class B, class C, real creative class A shares. If you buy a class A share in a mutual fund. Now, the mutual fund still owns the same stocks. It doesn't matter where you buy class A, class B, class C. It's just the difference between how the fees are charged and the expenses. Class A shares typically have an upfront fee to get into it. So you put $1,000 in and you get that first statement. It says,$970. You go, where'd my $30 go? Hell, it went into their pocket. They're getting their fee up front, and they'll still take expenses every year after that, but they're lower because they took a big fee up front. Okay, now then there is class B shares, which flips it so they'll have a higher expenses and they'll have an exit fee. So if you try to get out too soon, then they're going to charge you a fee for exiting too soon. So you'll have the fee on the back end. Then class C shares. Class C shares are a little different. They're more normalized. So you would have higher expense ratios on the class C shares, but it would be throughout. Now, there is a small exit fee typically on those, but that will be waived if you held it for a period of time. So know that even though you're buying into a mutual fund, you want to be aware of, is it class a, class b, or class c? Because the fees, the expenses and the loads, what they call them, either back end load or front end load, which are just fees. Another word for fees are going to hit you. So that's mutual funds. Let's take a look at the next animal, which is index funds. All right. Now, most 401 ks and most pensions or stuff like that have access to index funds. And the reason for it is because they wanted to create something that had lower fees. So this is how this plays out. What are index funds? Well, they're effectively just a type of a mutual fund or an ETF. And we'll talk about etfs in a second that are designed to track an index. Could be the s and P 500, the top 500 companies in the standard pores. It could be the total stock market. It could be any type of index. You just got to look at it. And what it's meant to do is to give you an exposure to the broader market. If I want to sit back and say, look, I want to invest in the total stock market, thousands of stocks, so I can get a total stock market index fund. And basically I put money into the fund. They've invested in almost all the stocks that are on the stock market, and I have access or interest in all of them indirectly. So it gives you a substantial amount of stock market exposure with a lot of diversification. Now, these index funds can be structured any way to track any index. So you've got to be mindful of it. So what are the pros and cons here? Probably the biggest is this, is that you get the diversification, but you get the diversification at a much lower fee structure than you would with the mutual ones. There are no front end loads or back end loads. Typically, it is something that you get a chance to get a diversified portfolio, get in there, able to have that, and know that it's going to track the market. Now, it's not actively managed like a mutual fund. There is no one overseeing it so that's why they can keep the expense structured lower. And if the expense structure is lower, more money is available to go in your pocket. That's a good thing. All right, so that's the thing that we're trying to do. It is also easy to invest. It's simple. You pick a market segment you want to be in, and you say, here's the different index funds. Which one do I want to go into? This is the thing that you're going to do. It's simple to get in. Okay, what are the cons? All right, so the cons here are you have no control of the holdings. They will track the index. It will automatically adjust in there. And because they're tracking the market, the returns are going to be more average market returns, which if you look at the market, if it's doing 8% in the long term, on average, that's not a horrible return. Are you going to hit 20%? Probably not, but you will probably in a year here or a year there, depending on what's going on in the market. But you can also lose 20% depending on what's going on in the market. But it's very dependent on which index fund you're in and which index it's tracking. So it's really important to realize that they're not all the same. Okay. You still have an issue with potential taxes here because of the way that they're traded and because of the way that they're managed. So you want to be aware of that. The other thing with this is this trades again like a mutual fund. So when you put the order in, it doesn't execute till the end of the day. So that's still something that happens with index funds. It doesn't trade like a stock. You put an order in to sell a stock or buy a stock, it happens within minutes and you're done. So you know what you got in at, you know what you got out at, but you don't with an index fund, you don't with a mutual fund. That's the difference. Who are they suitable for? I think that really, these are for those folks that really want to sit back and say, look, I just want market matching returns. I want low fees. I want to keep as much in my pocket. I don't want to get into all the craziness of trying to actively manage it and everything. I'll be honest with you, most of my investing, the major portion of my portfolio is via index funds and etfs, and we are creating, in a sense, a managed structure by matching the index funds and the etfs to my risk tolerance, risk capacity, risk need, and our strategy and the plan. Okay? So we're doing it ourselves without having active managers in each of the funds to make that happen. So that's an index fund, really, that leads us to the idea of ets. Ets, these are what they call exchange traded funds, okay? They're a little different than index funds in the sense that what this is is a type of fund that will buy assets, stocks, bonds and commodities, and you'll buy units in it. You're buying a piece of the basket, and so you indirectly have ownership in those, just like you do with some of the other ones. But this trades like a stock. So when I put the order in to buy or sell an ETF, it will execute within minutes. Okay? Typically within minutes. So I know specifically what I got in at, what I'm getting out at, and I'm not waiting till the end of the day. It's very much more like an individual stock as you go through with it. Now, there's some pros to it, and those pros are like one liquidity because it trades throughout the day. And like a stock, I can get in and out. I can do things with this that I can't necessarily do with an index fund or a mutual fund, and I can do it with lower fees because it's just tracking indexes. Again, it's an exchange traded fund. There isn't the active measurement, there isn't all the active work involved with it. So you have lower fees. That means more is going into your pocket to make that happen. They're more tax efficient, so you're not triggering some sort of tax because of the trading and because of the way they're structured. It's very transparent. You know specifically what the holdings are, and they're disclosed each and every day. So you know exactly what's inside it on a daily basis if you want to. Okay, if you want to. Now, there's always cons to it, so let's just look at some of the cons with this. First is that there's some trading costs. When you buy and sell into etfs, the broker is going to have some fees involved with that. So you want to make sure you're at the right type of discount broker. The lowest fees possible. Remember, we're trying to keep as much money in our pocket to work for us rather than work for them. All right, then the second thing is that there's this thing called the bid ask spread because they trade like stocks. There's people that have an asking price and people that are bidding. And what happens is that there's a disconnect sometimes between what a stock is bought for or an ETF interest is bought for and what it's sold for. And that gap creates what they call the bid ask spread, which can cost money because of the slight differential. If you buy in and try to sell out right away, you'll say, wait a second, I did it right away. Well, it's because there's a bid ask spread that means that you're buying at something higher than you could actually sell out immediately after. So you want to be aware of that. Some of them have big bid ask spreads, some have really narrow ones. So it's something to think about. But we're not trading these things. Mostly, we're investing them. So it shouldn't have a huge impact as you go through it. So who are these really suitable for? I think that these are good for investors that just want a stock like portfolio, that want the diversification, that can sit back and put a number of etfs together to build a portfolio. A two fund, three fund, four fund portfolio. That gives them the diversification, gives them the exposure, gives them the things that they want in a low fee, low cost type of portfolio that is built based on their risk capacity, their risk tolerance, their risk need, and their facts and circumstances. All right, so that's it. I mean, you can do individual stocks. I don't recommend it, especially when starting out. I do individual stocks, but it's after I had critical mass in my portfolio. My portfolio is primarily built on etfs and index funds. I might have one or two mutual funds, but I try to steer clear of them because I don't want the fees. I want to keep the fees down as much as possible so I can keep as much in my pocket as possible and working for me. Remember the idea behind building that money machine to have financial freedom? We want that money machine working for us. And the idea behind the money machine is to make sure your money is working harder for you than you ever did for it. So I hope that this helps. I hope this maybe clears it up for you. Individual stocks, mutual funds, index funds, etfs, knowing the differences so you can be more informed, get a little more understanding, so you can make a better decision about your financial future and your financial destiny. As I always say, financial freedom, it's your birthright. It's just about us going out there and claiming it until I get a chance to see you in another episode, another video another show or on the road. Always, always strive to live a life that outlives you. Cheers. Thank you for listening to the affluent entrepreneur show. With me, your host, Mel Abraham. If you want to achieve financial liberation to create an affluent lifestyle, join me in the affluent entrepreneur facebook group now by going to melabraham.com/group, and I'll see you there.