Course outline
Lesson 7 of 208 min read
Funds, index funds and ETFs
A fund pools money from many investors to buy many investments at once. Low-cost index funds are the backbone of most beginner portfolios.
Buying a basket instead of one egg
A fund collects money from lots of investors and buys a large collection of stocks, bonds or both. One purchase can give you a slice of hundreds or thousands of companies.
That makes it easy to spread risk. If one company in a 500-company fund collapses, it's a small dent rather than a disaster.
Active funds versus index funds
- Actively managed funds pay professionals to pick investments they hope will beat the market. They typically charge higher fees.
- Index funds simply hold everything in a market index, such as the S&P 500 (about 500 large US companies) or a total market index (thousands of companies). They aim to match the market, not beat it, and usually charge very low fees.
Long-running research, including the S&P SPIVA reports, has found that most actively managed funds trail their index over 10 to 15 years, largely because of their higher costs. That's why many experts suggest low-cost index funds for most people.
ETFs and mutual funds
| ETF (exchange-traded fund) | Mutual fund | |
|---|---|---|
| How you buy | Like a stock, through any brokerage, during market hours | From the fund company or a brokerage, once a day at the closing price |
| Minimum | One share, or less with fractional shares | Sometimes a set minimum, like $1,000 |
| Can it be an index fund? | Yes, most are | Yes, many are |
Both can be excellent. What matters most is what the fund holds and what it costs, which you'll learn to check in the fees lesson.
Key takeaways
- A fund lets you own many investments with one purchase.
- Index funds track a market instead of trying to beat it, usually at very low cost.
- ETFs and mutual funds are two wrappers; check what's inside and the fee.
Key terms
- Diversification
- Spreading money across many investments so no single one can do too much damage.
- ETF
- Exchange-traded fund. A fund holding many investments that trades on a stock exchange like a single stock.
- Index fund
- A fund that tracks a market index, such as the S&P 500, instead of trying to pick winners.
- Mutual fund
- A fund that pools investors' money to buy many investments. Orders are filled once a day at the closing price.
Check your understanding
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