Military Finances 101: ETF. Mutual Fund. What's the Difference?
Managing Your FinancesAs you get your start in the military, you'll definitely want to invest in the Thrift Savings Plan (TSP). This is especially true if you're covered by the Blended Retirement System (BRS). But what if you want to invest beyond TSP? If you go outside TSP into perhaps an IRA or taxable investment account and don't want to invest in individual stocks and bonds, you may want to consider the two most common types of pooled investments. The two types are Mutual Funds and ETFs.
Mutual Funds. The Original Pooled Investment
Mutual funds are a product offered by mutual fund companies (kind of make sense). These investment vehicles are a basket that can hold a lot of different securities. They can hold stocks, bonds, stocks and/or bonds from other countries, and a very close cousin to a mutual fund, Real Estate Investment Trusts (REITS) can hold investment real estate. Mutual funds are priced based on the Net Asset Value (NAV) of the underlying assets at the close of trading each day.
Mutual funds can be actively managed or passive. In an actively managed mutual fund, the manager tries to predict future market moves and to outperform market indexes like the S&P 500. Passive funds on the other hand, try to replicate an index and not predict future movements.
You can buy mutual funds either directly from a mutual fund company or an financial adviser. Depending on the class of mutual funds shares, there may be an upfront load (fee) deducted by the amount you invest. Conversely mutual funds can be no-load. These types of mutual funds are normally sold directly by mutual fund company. Mutual funds can have other fees such as 12(b)-1 fees which return revenue to advisors for marketing the mutual funds.
ETFs. The New Guys
ETFs have been around for awhile, but not as long as mutual funds. Like mutual funds, ETFs are a basket that holds underlying securities. Unlike mutual funds, ETFs trade on the stock market and their value fluctuates throughout the day. Also, unlike mutual funds, ETFs are normally bought from or sold to another investor. Normally, but not always, investors who purchase ETFs, pay a trading fee to the broker that executes the trade.
ETFs tend to be passive in their management, though there are more and more that actively attempt to beat the market. There are some ETFs that are quite speculative, and you need to be careful if you use them. Inverse and 2X and 3X ETFs can be especially risky.
Beyond that, ETFs are pretty much like mutual funds
Which Should I Chose?
When available, I lean towards ETFs. Here are some of the reasons:
- ETFs tend to have lower expense ratios than an equivalent mutual fund. This has to do with the fact that less overhead is required to manage the basket
- ETFs tend to be a little more tax efficient. Since ETFs normally are bought and sold investor to investor, this means the manager isn't required to sell assets to pay for cash outflows. While this won't occur every day, there will be more capital gains distributed, in general, by a mutual fund than an ETF
There are a couple of good reasons to consider mutual funds as well. This can be especially true if you're just getting started investing.
- Mutual funds can be purchased in fractional shares (you can buy fractional shares of some, but not many ETFs). This works better if you want to dollar cost average
- Dividend reinvestment works better with mutual funds than ETFs
Military Finances Can be Complicated
Active and retired military members have different financial considerations than civilians. Their tax situation is even more complicated. If you'd like to talk to a financial planner and advisor that works with military clients each and every day, give us a call.
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