Choosing the Right Investment Vehicle

As the financial markets continue to expand, keeping a diversified portfolio simply by picking individual stocks is becoming harder and harder to maintain. To combat this complexity, mutual funds and exchange traded funds (ETFs) allow an individual investor to invest in baskets of stocks or bonds, without having to shell out as much cash, or to deal with the hassle of watching each one of the stocks in the basket. For example, to buy just one share of each of the top 10 holdings in the S&P 500 would cost over $12,000, let alone buying the proper weighting of each company within the index.

When looking at the baskets of investments offered through mutual funds or ETFs, there are several options available. The first can be a “passive” investment, meaning that the ETF just tracks major market indexes (like the S&P 500). The other is an “active” manager, meaning that an individual or team of people will actively pick stocks or bonds that they believe will outperform the standard market indexes.

The most difficult choice to make when it comes to investing your hard-earned savings is what to invest in. Today, we’ll break down a couple of investment options for you to help you decide what may be the best option for you.

Individual Stocks and Bonds

The first investment option that most people are aware of is investment in individual positions of stocks (like Apple, Google, Ford, and many others) or bonds (Treasury bonds, mortgage-backed securities, corporate bonds, and others). This method of investing is often considered a high-risk method of investing. Although investing in a few positions will allow for higher potential returns, the downside of investing like this is that if any of your positions perform poorly, your entire portfolio will suffer as a result.

Actively Managed Mutual Funds

Mutual funds are actively managed by a manager or team of managers that create a portfolio around a stated strategy. For example, some managers may look to invest in long-term innovative companies, others may look to invest in emerging market bonds (bonds that are issued by countries that are not fully developed, but are rapidly growing). The options are nearly endless for this type of investment.

Investing in actively managed mutual funds is the best option when you believe in a manager or strategy that could outperform the market. For example, some mutual funds offer low volatility or other downside risk options. Additionally, certain aspects of the market are more efficient than others. Tracking these indexes, such as the S&P 500, often result in managers who underperform over long term horizons. Others (some bond markets for example) are less efficient and thus benefit from having an intelligent manager navigate the proper investments.

While there are some benefits to actively managed mutual funds, the downsides of investing in these funds can also be significant. Assuming these investments are held in taxable accounts, actively managed mutual funds are often tax-inefficient. This means that the taxable income they produce could create more drag on the true performance of the fund when factoring in the tax cost. Also, since these funds require more active work from professionals, their fees tend to be higher. While the expense ratio will vary from fund to fund, actively managed funds can often be double or triple the cost of ETFs that passively invest in similar assets.

Exchange Traded Funds

Exchange traded funds are passive investments that track certain indexes, such as the S&P 500, the Nasdaq Composite, or the Dow Jones Industrial Average. These investments are referred to as passive, as they are not looking to beat the market, but match the market performance.

There are several incentives to investing in ETFs. First, since ETFs are somewhat easier to create, there are often more niche ETFs to invest in. Some niche ETFs include socially responsible funds or specific commodities and precious metals. Additionally, the expense ratios associated with ETFs are also significantly cheaper when compared to mutual funds. Finally, most ETFs are some of the most tax-efficient investments. Because they are not being actively traded like most mutual funds, holding these in a taxable account will be more desirable.

Unfortunately, as you get into niche ETFs, you also can experience wilder price swings. For active traders who are going in and out of investments often, this can result in significant losses. Also, while it is true that the fees of ETFs can be lower than most mutual funds, fees for ETFs often include fee waivers that may fade over time. This means that over time, the fees of an ETF can creep higher than initially experienced. It is important to check any ETFs that you are invested in to make sure that the total fee has not increased due to any fee waivers expiring.

Overall, choosing what vehicle to invest in can be just as important as deciding what investments make up your portfolio. While there isn’t a one-size-fits-all approach to investing, knowing what the most appropriate solution for you is something to consider.

This article is a general communication being provided for informational and educational purposes only and is not meant to be taken as tax advice, investment advice or a recommendation for any specific investment product or strategy. The information contained herein does not take your financial situation, investment objective or risk tolerance into consideration. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. Any examples are hypothetical and for illustration purposes only. All investments involve risk and can lose value, the market value and income from investments may fluctuate in amounts greater than the market. All information discussed herein is current only as of the date of publication and is subject to change at any time without notice. Forecasts may not be realized due to a multitude of factors, including but not limited to, changes in economic conditions, corporate profitability, geopolitical conditions, inflation or US tax policy. This material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed.

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