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Investment Opportunities in Mutual Funds and Exchange-Traded Funds

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  • 0:24 Mutual Funds: An Overview
  • 1:15 Advantages of Mutual Funds
  • 2:14 Disadvantages of Mutual Funds
  • 2:53 Exchange-Traded Funds
  • 4:00 Advantages & Disadvantages
  • 4:38 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
Investing in the stock market is not limited to individual stocks. Investors can also invest in mutual funds and exchange-traded funds. In this lesson, you'll learn about these opportunities, as well as their advantages and disadvantages.

Investing in the Stock Market

Meet Mandy. She is a busy young professional trying to build her career. She also wants to start building her nest egg by investing in the stock market. She could invest in individual stocks and bonds. However, she also knows that investing in individual stocks and bonds are not her only option.

Mutual Funds: An Overview

Mandy can invest in mutual funds. A mutual fund is an investment fund that is managed by an investment company. The fund raises money for its investment from shareholders, such as Mandy. A mutual fund is professionally managed and will typically utilize a diversified portfolio strategy often consisting of a variety of investments, including stocks, bonds, options and currencies, among others.

Different mutual funds have different investment strategies. Some focus on appreciating in value and invest aggressively, while others are more conservative and focus on providing income for its shareholders. The fund will charge a management fee paid by the shareholders, which is a percentage of the assets it has under management. For example, if a fund has one billion dollars worth of assets under management and charges a management fee of 0.3%, the annual management fee for that fund is three million.

Advantages of Mutual Funds

Investing in mutual funds offers some important advantages for Mandy. Successful investing requires knowledge and time to research. Mandy doesn't have the knowledge or the time for the research necessary to make informed investment decisions. A money manager provides professional asset management for the mutual fund and does all the legwork for Mandy and the other shareholders. These money managers have the knowledge, time, staff and resources to make well-informed investment decisions.

A wise investor doesn't put all her eggs in one basket. A fundamental principle of investment is diversification. Diversification is an investment strategy where a person invests in a variety of different types of investments with different characteristics. The idea is that a diversified investment portfolio will reduce risk because if one investment does poorly, another investment will probably be doing well. A mutual fund automatically gives Mandy a good level of diversification because a mutual fund is a portfolio of diverse investments.

Disadvantages of Mutual Funds

Mutual funds do have some disadvantages for investors, like Mandy. As we discussed above, mutual funds charge fees for the management of the fund. Those fees can cut into Mandy's earnings on her investment.

Another disadvantage is that the mutual funds generally do not provide an opportunity for large returns compared to single stock investments. Remember, mutual funds use a diversification strategy. More often than not, some of the investments will be winners and some losers. While this keeps the risk of loss lower, it also means it's rarer for huge gains. Finally, after Mandy makes her investment in a mutual fund, she'll have no control over how her money is invested except to cash out of it.

Exchange-Traded Funds

An exchange-traded fund, or ETF, is an investment product that is similar to a mutual fund. However, shares of exchange-traded funds are traded on an exchange, like a stock. You can think of ETFs as mutual funds that trade like stock.

Exchange-traded funds try to match the same return as a particular market index. For example, the S&P 500 Index Fund invests in a portfolio of stocks in the Standards & Poor Index in an attempt to earn the same return as the index itself; if the S&P increases by 8%, the S&P Index Fund ideally will match it.

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