When building out an investment portfolio, investors have many options at hand, including stocks, mutual funds and exchange traded funds.
While many are familiar with stocks and mutual funds, ETFs are relatively new to the investment world.
To start off, open-end mutual funds are backed by a group of investors who pool their money and a manager would invest that cash pool according to a specific strategy or track a certain index, according to The Motley Fool.
ETFs, like mutual funds, allow an investor to gain diversified exposure to a group of securities through one single investment. However, there are some key differences. For instance, investors can buy and sell ETF shares throughout the trading day, like an ordinary stock, on a brokerage account. Additionally, the majority of the ETF universe is comprised of passive, index-based offerings – there are only 130 actively managed ETFs of 1,754 U.S.-listed ETFs on the market.
Investors would pick a mutual fund or ETF over an individual stock for diversification purposes. An investor may invest all of his or her money in a single stock, but one’s wealth would be tied to the outlook of that single company. With a fund, an investor may access broader markets as many ETFs include exposure to hundreds if not thousands of various company stocks. However, ETF investors may not enjoy the same level of upside potential since ETFs will hold various components with varying performances.