Mutual Fund ETF Fulgent Wealth Management

What are Mutual Funds and ETFs?

A mutual fund is a diversified basket of securities that are generally comprised of hundreds of stocks and bonds.

What does that mean?

Imagine you had $50,000 to invest and chose the S&P 500 Index. That would mean you would have invested $100 in 500 different companies. So if a single company goes out of business right away, you would still have $49,900 invested with 499 different companies. You didn’t lose all of your investment. A mutual fund is a method of diversification, which is used to protect your downside risk.

Why do people invest in mutual funds?

Before mutual funds became popular in the 1970s and 1980s, you or your investment manager would have to handpick each individual investment, which not only required a lot of time and research making investment management costly and ineffective.

A mutual fund not only allowed for hundreds of investments to be lumped together in one portfolio, it lowered the cost of investment management and decreased risk via diversification.

What to look out for

Be careful of high commission mutual funds such as A Share, B Share and C Share mutual funds. Look for no-load, commission-free, no transaction fee portfolios.

Also be mindful of the expense ratio, which is the annual fee for the mutual fund that is paid through the portfolio.

“A” Share Mutual Fund:

Investing in an A Share (front-end loaded) means you pay your advisor an upfront commission to invest. For example,  if you had $100,000 to invest and your advisor was paid a 6% commission, your portfolio would be $6,000 lighter and would have already been at a 6% loss. Depending on annual performance, this could take a year to recover from.

That’s right, if you didn’t know any better you could lose a whole year of investment gains by going with an A Share mutual fund.

This could be especially bad as an A Share portfolio is intended to be invested once, however, some advisors may switch your portfolio every 5-6 years meaning twice a decade you are giving up up-to 12% of your portfolio.

A Shares typically have an expense ratio of around 1%, although it can vary.

“B” Share Mutual Fund:

Investing in a B Share (back-end load) means you pay nothing upfront but you will pay a hefty commission if the portfolio is sold or exchanged before a five-six year window. For example, if you invested $100,000 for four and a half years, you would have paid nothing upfront, but your advisor decides to move the portfolio to a different investment and restarts the five-six year window and captures a commission between 1-6%.

B Shares typically have an expense ratio of around 1.5%, although it can vary.

“C” Share Mutual Fund:

Investing in a C Share (sometimes mistakenly referred to as a no-load fund) means you do not pay a front end commission, you pay nothing to get into it, but if you exit the fund within the first year you will usually pay a contingent deferred sales charge of around 1-2%.

C Shares have the highest expense ratio of around 2%, although it can vary.

What is a “true no-load fund”?

There are many mutual fund and investment options known as No-Load, No Commission, No Transaction Fee Funds. Meaning you don’t pay anything to enter, exit, invest or purchase a portfolio, you simply pay the expense ratio out of the portfolio every year.

These funds are a better buy as they can save you a significant amount of money up-front, on the back end and/or year over year.

Active versus Passive (Index)

What is a Passive Fund?

A Passive Mutual Fund (also known as Indexed Mutual Fund) invests and tracks a specific market index.

For Example, the Standard & Poor’s 500 Index tracks  500 large companies listed on the US Stock Exchange. You will take gains and losses based on exactly how those 500 companies will do.

What is an Active Fund?

An Active Mutual Fund is a mutual fund that has investment managers and a specific goal in mind.

For Example, Mutual Fund #1 could have an investment objective of aggressive domestic growth and may have five analysts researching American companies they believe will grow. They could be correct or incorrect in their assumption, but they will still charge the annual expense ratio.

Mutual Fund #2 could have an investment objective of domestic value and may have five analysts researching American companies they believe to be stable. They could be correct or incorrect in their assumption, but they will still charge the annual expense ratio.

Which is better for me?

There’s no right or wrong answer with an active mutual fund or an indexed (passive) mutual fund. This is best answered by understanding your investment objective and investment philosophy.

What is an ETF?

An ETF (Exchange Traded Fund) is an investment that has potentially hundreds of investments inside of it like a mutual fund but can be traded multiple times per day like a stock. Typically the investments are passive but can be active as well.

This is a lot of information, which do I choose?

Realistically speaking, there’s no one way to invest, it’s not a science. There are methods and theories which are best accomplished by understanding your goals, time horizon and risk tolerance, then choosing your investments to fill those needs.
I usually try to be to the point and concise, if you have any questions that you feel could add to this article, feel free to email me brandon.young@fulgentwm.com