ETF vs. Index Fund: Which Is Right For You?
There are strengths, weaknesses, and best-use strategies for both index funds and exchange-traded funds (ETFs). They're similar in a lot of ways, and the terms are used interchangeably by some, but "index funds" typically refer to indexed mutual funds, while "ETFs" can refer to any type of ETF without regard to its holdings, goals, or fee structure.
Keep reading to learn more about how these products differ from each other and which could be right for you.
What's the Difference Between ETFs and Index Funds?
|Fund management style||Can be active or passive||Passive|
|Expense Ratios||Lower than mutual funds||Higher than indexed ETFs (though lower than active funds)|
|Price||Determined by trading throughout the day||Determined by NAV|
Fund Management Style
While ETFs can come in a wide variety of styles, both index funds and index ETFs fall under the heading of "indexing." Both involve investing in an underlying benchmark index. The primary reason for indexing is that index funds (both index ETFs and index mutual funds) can often beat actively managed funds in the long run.
Unlike actively managed funds, indexing relies on what the investment industry refers to as a passive investing strategy. Passive investments are not designed to outperform the market or a particular benchmark index, and this removes manager risk—the risk or inevitable eventuality that a money manager will make a mistake and end up losing to a benchmark index.
A top-performing actively managed fund might do well in the first few years. It achieves above-average returns, which attracts more investors. Then the assets of the fund grow too large to manage as well as they were managed in the past, and returns begin to shift from above-average to below-average.
By the time most investors discover a top-performing active fund, they've missed the above-average returns. You rarely capture the best returns because you've invested based primarily on past performance.
Passive investments such as index mutual funds and indexed ETFs have extremely low expense ratios compared to actively managed funds. This is another hurdle for the active manager to overcome, and it's difficult to do consistently over time.
Many index funds have expense ratios below 0.20%, and indexed ETFs can have expense ratios even lower, such as 0.10%. Actively managed funds often have expense ratios closer to 1%.
A passive fund can have a 1% or more advantage over actively managed mutual funds before the investing period begins, and lower expenses often translate to higher returns over time.
Lower expense ratios can provide a slight edge in returns over index funds for an investor, at least in theory. ETFs can have higher trading costs, however, depending on the brokerage you use.
The primary difference between these two terms is that "index funds" are typically mutual funds, and ETFs are traded like stocks, not mutual funds. This has an impact on the price you pay for the investment.
The price at which you might buy or sell a mutual fund isn't really a price—it's the net asset value (NAV) of the underlying securities. No matter when you place your trade during the day, your trade executes at the fund's NAV at the end of the trading day. If the prices of the securities held within the mutual fund rise or fall during the day, you have no control over the timing of execution of the trade. You get what you get at the end of the day, for better or worse.
ETF traders have the ability to place stock orders. This can help overcome some of the behavioral and pricing risks of day trading. An investor can choose a price at which a trade is executed with a limit order. They can choose a price below the current price and prevent a loss below that chosen price with a stop order. Investors don't have this type of flexible control with mutual funds.
However, since ETF trading is determined by price action rather than NAV, it is possible to pay more for an ETF than the total value of assets held within the ETF. The price of the ETF generally tracks close to the underlying value of securities, but it may not always exactly match.
Which Is Best For You?
ETFs and index funds are similar, but the best option for you will likely come down to trading style.
ETFs May Be Best For You If...
ETFs trade intra-day, like stocks. This can be an advantage if you're able to take advantage of price movements that occur during the day.
You can buy an ETF early in the trading day and capture its positive movementifyou believe the market is moving higher and you want to take advantage of that trend. The market can move higher or lower by as much as 1% or more on some days. This presents both risk and opportunity, depending on your accuracy in predicting the trend.
Index Funds May Be Best For You If...
If you don't care about trying to seize upon every opportunity the trading day presents, then you may be best off with index funds. Trading ETFs without learning the ins and outs of how trades work can leave you vulnerable to extra costs.
Part of the tradable aspect of ETFs is the "spread," the difference between the bid and ask price of a security. When ETFs aren't widely traded, the spread becomes wider and the costs of the spread become larger.
Jack Bogle, founder of Vanguard Investments and the pioneer of indexing, had his doubts about ETFs, although Vanguard has a large selection of them. Bogle warned that the popularity of ETFs is largely attributed to marketing by the financial industry. The popularity of ETFs might not be directly correlated to their practicality.
The ability to trade an index like stocks also creates a temptation to trade, which can encourage potentially damaging investing behaviors such as poor market timing and frequent trading increases expenses.
A Best-Of-Both Worlds Option
The index funds vs. ETF debate doesn't have to be an either/or question. It can be smart to consider both.
Fees and expenses are the enemies of the index investor, so the first consideration when choosing between the two is typically the expense ratio. There might also be some investment types where one fund has an advantage over another. An investor who wants to buy an index that closely mirrors the price movement of gold, for instance, will likely best achieve their goal by using the ETF called SPDR Gold Shares (GLD).
Finally, although past performance is no guarantee of future results, historical returns can reveal an index fund or ETF's ability to closely track the underlying index and thus provide an investor with greater potential returns in the future.
The Bottom Line
Choosing between index funds and ETFs is a matter of selecting the appropriate tool for the job. ETFs may offer lower expense ratios and greater flexibility, while index funds simplify a lot of the trading decisions an investor has to make.
An investor can wisely use both. You might choose to use an index mutual fund as a core holding and add ETFs that invest in sectors as satellite holdings to add diversity. Using investment tools for the appropriate purpose can create a synergistic effect where the whole portfolio is greater than the sum of its parts.
Frequently Asked Questions (FAQs)
What is a leveraged ETF?
While a standard ETF holds shares in the companies that make up the underlying index, a leveraged ETF holds derivatives that amplify the volatility of the index. For instance, QQQ is a popular ETF that tracks the biggest companies on the Nasdaq. TQQQ is a leveraged ETF that tracks the same companies but with three times the volatility. Leveraged ETFs can also be inverse, which means that they move in the opposite direction of the underlying index.
How do ETF dividends work?
From an investor's standpoint, ETF dividends are just the same as any other stock dividend. The ETF manager will collect dividends from companies throughout the quarter and then distribute them to ETF holders after accounting for any fees.
What is the SPY ETF?
The SPDR S&P 500 ETF Trust, which trades by the ticker "SPY," was the first ETF introduced to the market. It remains one of the most actively traded ETFs to this day—if not the most actively traded. It tracks the S&P 500 index and is often referenced as a gauge of the overall stock market.
How do you know which index fund to buy?
The best index fund for you depends on what your investment goals are. If you need to add stock market exposure, you could use a broad market fund like the Fidelity 500 Index Fund (FXAIX) or the Schwab S&P 500 Index Fund (SWPPX). If you need to add bond exposure, you could use a fund that focuses on bonds, like the Vanguard Long-Term Investment Grade Fund (VWESX) or the Vanguard Total Bond Market Fund (VBTLX).
How do you track the Russell 2000 with an index fund?
The Russell 2000 is an index that tracks small-cap companies. You can invest in it with index funds like the Fidelity Small-Cap Index Fund (FSSNX) and the Schwab Small-Cap Index Fund (SWSSX).
Could Index Funds Be ‘Worse Than Marxism’?
Economists and policy makers are worried that the Vanguard model of passive investment is hurting markets.
By Annie Lowrey
About the author: Annie Lowrey is a staff writer at The Atlantic, where she covers economic policy.
The stock market has had quite a year. Plenty of cash is sloshing around, the pandemic recession notwithstanding, thanks to loose monetary policy, rampant inequality, crypto-speculation, and helicopter drops of cash. Plenty of bored people are reading market rumors on the internet, pumping and dumping penny stocks, riding GameStop to the moon, and bidding up the price of esoteric currencies and digital artworks. The markets are swooning and hitting new highs as kitchen-table investing—laptop-on-the-couch investing, really—is having a heyday not seen since the late 1990s.
Yet economists, policy makers, and investors are worried that American markets have become inert—the product of a decades-long trend, not a months-long one. For millions of Americans, getting into the market no longer means picking stocks or hiring a portfolio manager to pick them for you. It means pushing money into an index fund, as offered by financial giants such as Vanguard, BlackRock, and State Street, otherwise known as the Big Three.
With index funds, nobody’s behind the scenes, dumping bad investments and selecting good ones. Nobody’s making a bet on shorting Tesla or going long on Apple. Nobody’s hedging Europe and plowing money into Vietnam. Nobody is doing much of anything at all. These funds are “passively managed,” in investor-speak. They generally buy and sell stocks when those stocks enter or exit indices, such as the S&P 500, and size their holdings according to metrics such as market value. Index funds mirror the market, in other words, rather than trying to pick winners and losers within it.
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Thanks to their ultralow fees and stellar long-term performance, these investment vehicles have soaked up more and more money since being developed by Vanguard’s Jack Bogle in the 1970s. At first, Wall Street was skeptical that investors would accept making what the market made rather than betting on a market-beating return. But as of 2016, investors worldwide were pulling more than $300 billion a year out of actively managed funds and pushing more than $500 billion a year into index funds. Some $11 trillion is now invested in index funds, up from $2 trillion a decade ago. And as of 2019, more money is invested in passive funds than in active funds in the United States.
Indexing has gone big, very big. For nine in 10 companies on the S&P 500, their largest single shareholder is one of the Big Three. For many, the big indexers control 20 percent or more of their shares. Index funds now control 20 to 30 percent of the American equities market, if not more.
Indexing has also gone small, very small. Although many financial institutions offer index funds to their clients, the Big Three control 80 or 90 percent of the market. The Harvard Law professor John Coates has argued that in the near future, just 12 management professionals—meaning a dozen people, not a dozen management committees or firms, mind you—will likely have “practical power over the majority of U.S. public companies.”
This financial revolution has been unquestionably good for the people lucky enough to have money to invest: They’ve gotten better returns for lower fees, as index funds shunt billions of dollars away from financial middlemen and toward regular families. Yet it has also moved the country toward a peculiar kind of financial oligarchy, one that might not be good for the economy as a whole.
The problem in American finance right now is not that the public markets are overrun with failsons picking up stock tips on Reddit, investors gambling on art tokens, and rich people flooding cash into Special Purpose Acquisition Companies, or SPACs. The problem is that the public markets have been cornered by a group of investment managers small enough to fit at a lunch counter, dedicated to quiescence and inertia.
Before index funds, if you wanted to get into the stock market, you had a few choices. You could pick stocks yourself, using a broker to buy and sell them. (Nowadays, you can easily buy and sell on your own.) Or you could buy into a mutual fund—a collection of investments selected by a vetted manager, promising solid returns in exchange for an annual fee.
Then Bogle, the head of a mutual-fund company, turned on the industry. He argued that mutual-fund fees were exorbitant, that mutual funds generally failed to beat the market, and that fund employees had an obvious conflict of interest: Was their priority to maximize returns for the people who bought into the mutual fund, or to make money for the company? He set up a company called Vanguard offering a new kind of mutual fund, one that would buy and hold every stock or bond on a major index and that would devote itself to driving fees as low as possible. Other companies, including Fidelity, State Street, and BlackRock, soon mimicked this strategy, later adding exchange-traded options, or ETFs.
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The strategy sounds implausible. But it works. Passively managed investment options do not just outperform actively managed ones in terms of both better returns and lower fees. They eat their lunch.
Let’s imagine that a decade ago you invested $100 in an index fund charging a 0.04 percent fee and $100 in a traditional mutual fund charging a 1.5 percent fee. Let’s also imagine that the index fund tracked the S&P 500, and that the mutual fund ended up returning what the S&P 500 returned. Your passively invested $100 would have turned into $356.66 in 10 years. Your traditionally invested $100 would have turned into $313.37.
Actively managed investment options could make up for their higher fees with higher returns. And some do, some of the time. Yet scores of industry and academic studies stretching over decades show that trying to beat the market tends to result in lower returns than just buying the market. Only a quarter of actively managed mutual funds exceeded the returns of their passively managed cousins in the decade leading up to 2019, according to research by Morningstar. That joke about meditation applies to money management too: Don’t just do something; sit there.
Compelled by the math, millions of investors have decided to do less to make more. Competition among the firms offering index funds has driven fees to scratch—some funds charge no fees at all—versus 1.5 percent or more, sometimes much more, for actively managed options. Cash has poured in. Now passive is bigger than active.
While that shift has redounded to the benefit of the Vanguards of the world, it has also redounded to the benefit of retail investors. Index funds mean less money for mutual-fund managers and more money for Mom and Dad: According to Morningstar, investors saved $6 billion in fees by switching to passive management in 2019 alone. “This is on-net positive for society,” Jonathan Brogaard, a finance professor at the University of Utah’s David Eccles School of Business, told me. “You are getting the same exposure to the markets for a tenth of a cost. It’s a no-brainer.”
What might be good for retail investors might not be good for the financial markets, public companies, or the American economy writ large, and the passive revolution’s scope has raised all sorts of hand-wringing and red-flagging. Analysts at Bernstein have called passive investing “worse than Marxism.” The investor Michael Burry, of The Big Short fame, has called it a “bubble,” and a co-head of Goldman Sachs’s investment-management division has warned about froth too. Shortly before his death in 2019, Bogle himself warned that index funds’ dominance might not “serve the national interest.”
One primary concern comes from the analysts at Bernstein: “A supposedly capitalist economy where the only investment is passive is worse than either a centrally planned economy or an economy with active, market-led capital management.” The point of their research note, if rendered a touch inscrutable with references to Hayek and the Gossnab, is about market signals and capital allocation.
Active managers direct investment dollars to companies on the basis of those companies’ research-and-development prospects, human capital, regulatory outlook, and so on. They take new information and price it into a company’s stock when buying and selling shares. If Company A’s stock price tanks when it announces a major scandal, that’s because active investors are selling. If Company B’s shares soar when it announces it’s entering a new market, that’s because active investors are buying.
Passive investors, by contrast, ignore annual reports and market rumors. They do nothing with trading-floor gossip. They make no attempt to research what to invest in and what to skip. Whether holding international or domestic assets, holding stocks or bonds, or using a mutual-fund structure or an ETF structure, they just mirror the market. Big U.S.-stock index funds buy big U.S. stocks just because they’re big U.S. stocks.
That commitment to inertia worries the Bernstein analysts, who point out that in a world with exclusively passive investors, capital will get allocated only to the big companies and not necessarily to good, promising, or efficient companies. A gravitational, big-getting-bigger effect would dominate stock-price movements. At least in a Soviet-type centrally planned economy, apparatchiks would be making some attempt to allocate resources efficiently.
The world the Bernstein analysts fear has not arrived, at least not yet: Passive management is merely a giant phenomenon, not an all-encompassing one. Hundreds of actively managed mutual funds are still out there, as are legions of day traders, hedge funds, and private offices buying and selling and buying and selling. Stock prices still move around, sometimes dramatically, on the basis of new data and new ideas.
Still, passive investing may well be degrading the informational content of the markets, messing up price signals and making business decisions harder as a result. Brogaard and two co-authors, Matthew Ringgenberg, also of the University of Utah, and David Sovich, of the University of Kentucky, have shown as much in a recent paper. They start with a look at a somewhat different kind of index fund: a commodity-futures index fund, which tracks the expected price of things such as gold and copper rather than the current price of Raytheon and Apple shares. Companies large and small base billions of dollars in expenditures on commodity futures. A firm might hold off on buying copper or rush a purchase of gold based on where it expects prices to go.
When one of these commodities ends up on an index, the firms that use that commodity in their business see a 6 percent increase in costs and a 40 percent decrease in operating profits, relative to firms without exposure to the commodity, the academics found. Their theory is that ETF trading shifts prices in subtle ways, making it harder for businesses to know when to buy their gold and copper. Corporate executives “are being influenced by what happens in the futures market, and what happens in the futures market is being influenced by ETF trading,” Brogaard told me.
More broadly, the Bernstein analysts, among others, worry that index-linked investing is increasing correlation, whereby the prices of stocks, bonds, and other assets move up or down or sideways together. As the financial economist Jeffrey Wurgler has written, the price fluctuations of a newly indexed stock “magically and quickly” change. A firm’s shares begin to move “more closely with its 499 new neighbors and less closely with the rest of the market. It is as if it has joined a new school of fish.”
A far bigger concern is that the rise of the indexers might be making American firms less competitive, through “common ownership,” in which the mega-asset managers control large stakes in multiple competitors in the same industry. The passive firms control big chunks of the airlines American, Delta, JetBlue, Southwest, and United, for instance, as well as big chunks of Bank of America, Citi, JPMorgan Chase, and Wells Fargo. Name an industry with a significant number of publicly traded firms—auto, retail, fast food, agribusiness, telecom—and the same is likely to be true.
The rise of common ownership might be perverting corporate behavior in weird ways, academics argue. Think about the incentives like this: Let’s imagine that you are a major shareholder in a public widget company. We’d expect you to desire—insist, even—that the company fight for market share and profits. But now imagine that you are a major shareholder in all the important widget companies. You would no longer really care which one succeeded, particularly not if one company doing better meant another company doing worse. You’d just care about the widget sector’s corporate profits, which would go up if the widget companies quit competing with one another and started raising prices to pad their bottom line.
The research on whether common ownership is in fact reducing competition is murky, contested, and sometimes contradictory. Still, one major paper showed that common ownership of airline stocks had the effect of raising ticket prices by 3 to 7 percent. A separate study showed that consumers are paying higher prices for prescription medicines because generic-drug makers have less incentive to compete with the companies making name-brand drugs. Yet another study showed that common ownership is leading retail banks to charge higher prices.
Asset managers have pushed back hard, describing this research as baseless and incoherent. “The economics literature purporting to link index funds and higher prices is based on fragile evidence and fundamental misconceptions,” one BlackRock white paper on the subject argues. “It does not provide a plausible causal explanation of how common ownership can lead to higher prices.”
Nobody is arguing that asset managers are facilitating corporate collusion or encouraging managers in rival firms to stop competing. New research suggests that common ownership could alter corporate executives’ financial incentives “without communication between shareholders and firms, coordination between firms, knowledge of shareholders’ incentives, or market-specific interventions by top managers.” Across firms, executive compensation seems to be more closely linked to a company’s performance when its shareholders are not invested in the company’s rivals, the study found. In other words, firms stop paying managers for performance when owned by the same people who own their rivals.
The market clout of the indexers raises other questions too. The actual owners of the stocks—not the index-fund managers but the people putting money into index funds—have little say over the companies they own. Vanguard, Fidelity, and State Street, not Mom and Dad, vote in shareholder elections. As John Coates, the Harvard professor, notes: “For the most valuable public company in the world, three individuals can in principle swing the vote of 17 percent of its shares. Generally, a significant fraction of shareholders do not vote, even if in contested battles. As a result, the 17 percent actually represents more like 25 percent or more of the likely votes in contested votes. That share of the vote will generally be pivotal.” In fact, the Big Three cast roughly 25 percent of the votes in S&P 500 companies.
Another worry is that these firms are too passive rather than too powerful. They are committed to being as lean and hands-off as possible, in order to reduce their fees. They do not tend to get involved in shareholder actions or small-bore corporate management, perhaps in part because any one company doing well against its peers is not of interest to the indexers, who want more assets under management and higher corporate profits.
It’s not easy being big.
Just last month, Senator Elizabeth Warren grilled Treasury Secretary Janet Yellen on whether BlackRock, with its $9 trillion in assets under management, is too big to fail. The Federal Trade Commission is contemplating whether the big index-fund families pose antitrust concerns. Government watchdogs have raised alarm bells about the revolving door, as the Biden administration continues to draw officials from the Big Three. In an interview with The Wall Street Journal, the chief executive officer of State Street said he thought it was “almost inevitable, when you see this kind of concentration, that it probably will make sense to do something about it.”
But figuring out what the appropriate restrictions are depends on determining just what the problem with the indexers is—are they distorting price signals, raising the cost of consumer goods, posing financial systemic risk, or do they just have the market cornered? Then, what to do about it? Common ownership is not a problem the government is used to handling.
Yet, thanks to the passive revolution, a broad variety and huge number of firms might have less incentive to compete. The effect on the real economy might look a lot like that of rising corporate concentration. And the two phenomena might be catalyzing one another, as index investing increases the number of mergers and makes them more lucrative.
In recent decades, the whole economy has gone on autopilot. Index-fund investment is hyperconcentrated. So is online retail. So are pharmaceuticals. So is broadband. Name an industry, and it is likely dominated by a handful of giant players. That has led to all sorts of deleterious downstream effects: suppressing workers’ wages, raising consumer prices, stifling innovation, stoking inequality, and suffocating business creation. The problem is not just the indexers. It is the public markets they reflect, where more chaos, more speculation, more risk, more innovation, and more competition are desperately needed.
The antidote lies not just in fixing passive investment, but in making markets be markets again. Perhaps we could all use a little more of that manic stock-picking energy, not less.
ETF vs. ETN: What's the Difference?
ETF vs. ETN: An Overview
Exchange-traded funds (ETFs) have gained ground on mutual funds with their often-lower fee structure and easier-to-understand stock-like price action. But ETFs have a not-so-well-known cousin—the exchange-traded note (ETN). ETNs are something that many retail investors may not know about. It's time to shed some light on the ETN and decide if this product has a place in your portfolio.
- Both ETFs and ETNs are designed to track an underlying asset.
- When you invest in an ETF, you are investing in a fund that holds the asset it tracks.
- An ETN is more like a bond. It's an unsecured debt note issued by an institution.
Exchange-Traded Funds (ETFs)
In practice, ETFs and ETNs are very similar. Both are designed to track an underlying asset, both often have lower expense ratios than actively managed mutual funds, and both trade on the major exchanges just like stocks.
The main difference is under the hood. When you invest in an ETF, you are investing in a fund that holds the asset it tracks. That asset can be stocks, bonds, gold (or other commodities), futures, or a combination of assets.
Exchange Traded Notes (ETNs)
An ETN is more like a bond. It's an unsecured debt note issued by an institution. Just like with a bond, an ETN can be held to maturity or bought or sold at will, and if the underwriter (usually a bank) were to go bankrupt, the investor would risk a total default.
For that reason, before investing in an ETN, research into the credit rating of the underwriter is an important metric. If the underwriter were to receive a credit downgrade, shares of the ETN would likely experience a downturn unrelated to the underlying product it's tracking.
Because an ETN does not pay dividends or interest income (unlike some ETFs) there are no yearly taxes due. Investors of ETNs only pay capital gains taxes when they sell the security.
Don't count out ETNs. These funds are more efficient than some ETFs and have favorable tax treatment.
ETNs have a notable advantage over ETFs given lower tracking errors. ETFs achieve varying levels of success when tracking their respective indexes. Investors will notice some amount of divergence from the index they track due to various factors, such as illiquid components.
Tracking error is virtually eliminated with ETNs, as the issuer agrees to pay the full value of the index (less the expense ratio). An ETN simply pays investors once the fund matures based on the price of the asset or index. There's no tracking error because the fund itself isn't actively tracking. Market forces will cause the fund to track the underlying instrument, but it's not the fund doing the tracking.
Which Is Better?
If you follow the age-old rule that says you should invest only into what you understand, ETFs are a better choice. Part-time investors have an easier time understanding products with stock-like characteristics. Since an ETN has bond-like characteristics, it's more complicated.
The most popular exchange-traded products are ETFs. One of the most popular ETNs is the JP Morgan Alerian MLP Index ETN (AMJ), which has an average daily volume of a little over 648,000 shares. The SPDR S&P 500 (SPY) ETF, by contrast, has an average daily volume of over 65.7 million shares. This clearly shows that investor appetite is heavily weighted toward ETFs.
The Bottom Line
ETFs are exponentially larger in collective volume than ETNs, but much like stocks versus bonds, stocks receive more attention from retail investors because they are easier to understand. Deciding that ETNs are right for your portfolio is appropriate, provided you have done the research and gained an appropriate level of understanding with which to make that determination.
Question and Answer
I am interested in investing in an index fund but I understand that they re-balance twice a year. I'm not sure when they do that. Is there an optimal time to buy into an index fund and are there times to avoid
Asked by Diane, Vancouver, Wash.
If you’re seriously considering investing in index funds, the optimal time to buy is now.
Answered by Sally French
Questions were submitted by readers and answered by New York Times experts. Read more questions and answers here.
Tell Me More
There’s no universally agreed upon time to invest in index funds but ideally, you want to buy when the market is low and sell when the market is high.
Since you probably don’t have a magic crystal ball, the only best time to buy into an index fund is now. The more time your money is in the stock market, the more time your money has to grow.
If you invest now, you’ll have some fortune on your side: The magic of compound interest. Compound interest generally results in your money growing at a faster rate than your initial investment alone would yield. This is because you earn interest on the money you invest and you earn interest on that interest. And here’s proof of how powerful compound interest can be:
Let’s compare two people who invested $5,000 each year and earned a 6 percent annual return.
If you started investing at age 32, you’d earn $557,173.80 by age 67. If you started 10 years earlier at age 22, you’d earn $1,063,717.57. That’s nearly twice as much, just by starting earlier.
As for how to invest, there are two main options and they depend on how much risk you feel comfortable taking on.
Dollar-cost averaging is generally the more conservative bet. You invest a fixed dollar amount on a recurring basis, regardless of the share price (as opposed to putting all the money you intend to invest into the stock market at once). The idea behind it is that you cut down on investment risks related to daily market fluctuations, as opposed to investing that lump sum all at once.
Lump-sum investing is pretty much exactly what it sounds like: You have a large, lump sum of money and you choose to invest it all at once, rather than in smaller sums over time.
Experts disagree on whether or not dollar-cost averaging is the right approach. A 2016 Vanguard study analyzing major market indexes dating as far back as 1926 found that lump-sum investing beats dollar-cost averaging strategies two out of three times on average.
But psychologically, lump-sum investing may be harder for some people. If you buy when the market is high, then a dip could trigger regret and possibly prompt you to panic sell. The approach you take will depend on how much risk you’re comfortable with.
If you buy index funds, you can choose to invest in stocks or bonds. If you’re young and you have lots of time until you need to access your investments, some experts recommend buying predominantly stock index funds (which are generally more risky in the short-term).
If you’re more risk-averse (typically people closer to retirement), consider buying mostly bond index funds, which are less prone to market ups and downs.
Answered by Sally French
Sally French is a writer for Wirecutter Money. She was previously at MarketWatch, a subsidiary of Dow Jones & Company. She's an avid traveler who's always on the hunt for the next best airport lounge and travel credit card, as well as a recent condo owner who's passionate about affordable housing.
Vs etf funds reddit index
The Best Target Date Funds For Retirement
We considered several factors to identify the best target date funds, including fees, performance, asset allocation and glide path.
Studies show that fees are a good indicator of a fund’s success. The lower the fees, the more likely the fund will outperform its more expensive counterparts. That’s not to say that expenses should be our only criteria, but they are an important one.
Most of the funds in our list have expense ratios below 50 basis points, and the most expensive is 80 basis points. There are target date funds, however, that cost more than 100 basis points. We believe that the performance of these funds do not justify the cost.
While target date funds have been around since the 1990s, performance data is limited. Because mutual fund companies have made changes to their target date funds, performance data are limited to 5-year returns. Our list will likely change as 10-year returns become available over the next several years.
The asset allocation of a target date retirement fund changes over time. In 2060 funds, equities are heavily weighted as investors have 40 years until retirement. In contrast, 2020 funds typically have no more than about 50% in equities, as those retiring in 2020 begin to use fund assets for living expenses.
While we weren’t looking for one “right” allocation, we did look for equity allocations above 80% in 2060 funds. The seven funds in our list typically allocated 90% to equities, although one fund had an 85% allocation. For the 2020 funds we examined, the range of equity allocations was more varied. They ranged from a high of 60% to a low of 35%.
Based on research by William Bengen (and others) on the 4% rule, we believe a retiree should have an equity allocation of at least 50%. As the allocation falls below this level, the longevity of the portfolio decreases. In other words, the odds of a retiree running out of money during retirement goes up. Unfortunately, while some target date funds maintain a 50% equity allocation at retirement, they all fall significantly below this level as the retiree ages.
Glide path describes how the asset allocation of a target date fund changes over time. There are “to” and “through” glide paths. With a “to” glide path, the allocation does not change once the fund reaches its designated year. For example, a 2020 fund’s asset allocation wouldn’t change in 2021, 2022, or even 2040.
In contrast, a “through” glide path continues to alter the asset allocation of a fund after its designated year. All of the funds in our list use a “through” glide path. For some, the changes in asset allocation stop after about five to seven years. For others, the changes continue for decades.
While we are agnostic on the “to” versus “through” debate, the same is not true for the stock to bond allocation. In all target date funds we examined, the equity allocations fall far below the 50% mark. As such, those using target date funds should carefully consider whether these funds best meet their needs in retirement.
SoFi Automated Investing
SoFi Automated Investing
Meme stocks: What are they and why you should be careful buying them
For those still itching to trade the next viral stock, invest only with money you can afford to lose. Before you invest, you should make sure you already have an emergency fund set aside, you've paid off your high-interest debt and you're already contributing to a retirement account (and meeting any 401(k) employer match, if applicable).
When you're ready to buy stocks, your first need to open a taxable brokerage account. Robinhood and Webull are two popular trading platforms for active investors, boasting easy-to-use mobile investing apps. Plus, Webull offers IRAs (traditional, Roth and rollover) so users can manage their retirement funds along with their stocks all in one place.
Both companies also allow investor to buy fractional shares of stocks, so you can buy a piece of the action without getting in too deep. Experts generally suggest keeping individual stock picking limited to 5% to 10% of your overall investment portfolio.
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