If you are looking for an instant diversification as you work to grow your wealth, a mutual fund (or an ETF) can be a good way to proceed. With either types of fund, you buy shares of several underlying investments at once, because a fund is a collection of investments (so when you invest in a fund, you actually invest in all of what the fund holds).
Mutual funds and ETFs make it fairly easy to diversify. You can diversify across companies or sectors, and you can even invest in the entire market, just to make sure you have a piece of everything. Funds also include investments beyond stocks; you can invest in bonds and more with the help of mutual funds and ETFs.
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As with all investments, though, there is a cost associated with investing in mutual funds and ETFs. When you buy shares, you will likely be charged a transaction fee, which is dependent on the brokerage firm that you use. Even if you aren’t charged a transaction fee (i.e., when you invest in a no transaction fee fund), you will need to pay a percentage of your invested money in the form of an expense ratio. This is a fee you pay based on the value of your holdings, usually a percentage. You might also be charged sales loads when you buy or sell shares in the mutual fund.
These costs can start to add up if you aren’t careful, eating into your returns, and reducing your ability to build wealth at the rate you would like.
If you want to keep your costs down, you need to carefully compare your options. Here are some things to pay attention to as you choose a low cost fund:
One of the best ways to keep down costs is to consider an index fund. An index fund is a type of mutual fund or ETF that tracks the performance of a specific index. It’s possible to find funds that track the entire US stock market, or that are limited to smaller indexes, like the Russell 2000. You can find funds that track foreign indexes, and even bond indexes.
Actively managed funds are problematic due to high fees. Even though some managed funds can beat the market, once you factor in the fees, very few managed funds actually beat the market. Even though index funds often lag their indicators, the reality is that their lower costs mean that investors have the potential to see better overall returns in many cases.
Now that you have identified ways to keep your costs low, you need to figure out which low cost fund — or funds — to add to your portfolio. Before you invest, it’s a good idea to consider your goals and your investment strategy. It’s possible to use low cost funds to create a portfolio that is diversified across asset class, geography, and sector.
Look at your risk tolerance and your asset allocation. Most brokers offer a variety of low cost options that can fit your needs, whether you are looking for growth, income, or capital preservation. Choose a mix of funds that will help you reach your goals and improve your portfolio.
Here are a few examples of how you can put together a well diversified portfolio using mutual funds and ETFs.
For beginners, this is by far the easiest way to invest. Target retirement funds are turnkey solutions to your retirement investment needs. You basically have to pick the closest retirement year, e.g., if you’re turning 65 in 2030, you could invest in a 2030 fund. Some of the lowest expense target retirement funds include:
Another common approach is to invest in 3 low cost funds consisting of a US stock fund, a International stock fund, and a bond fund. Bogleheads.org has a good explanation and a few examples. For example, a portfolio built with Schwab funds:
In additional to these examples, you can build your own portfolio using a tool like Personal Capital. With it, you can either analyse your current investments and trade out expensive ones for lower cost ones; or build a brand new one and use Personal Capital to project the expense for you.