Benjamin Wey is a Wall Street financier and journalist. Benjamin Wey has two master’s degrees and is a graduate of Columbia University. Benjamin Wey is also the CEO of New York Global Group. He shares his insight with our readers:
ATTENTION: Last time, I discussed the index fund (a mutual fund with a portfolio based on a specific stock index). If you are unfamiliar with index funds and/or the concept of a stock index, look that piece over before continuing.
Mutual funds can be broken into a multitude of different categories. One of the most basic groupings separates them into open-end, closed-end and exchange-traded. Open-end funds are the most popular type of mutual fund, and chances are, you or someone you know has invested in one. But don’t ignore the exchange-traded fund (commonly called the “ETF”), which is a variation on the index fund, or the closed-end fund. ETFs and closed-end funds offer somewhat of a “best of both worlds” scenario to investors because they are mutual funds that are traded like stocks.
One of the major advantages of the mutual fund is diversification, especially the index fund. Since the index fund makes such a wide variety of investments, you are essentially putting your eggs in many different baskets by investing in them. Also, don’t forget that index funds outperform some 50-80% of actively managed funds and have relatively low expenses. Since an ETF is essentially an index fund (except in a few recent cases where some actively managed ETFs have come into existence), an investor experiences the same benefits.
Unlike traditional, open-end mutual funds which are priced only once per day, the price of ETFs fluctuates throughout the day according to the market just like stocks. This makes for opportunities for speculative investment.
But for the average investor who isn’t interested in day trading, ETFs may be attractive because they have no minimum investment like many open-end mutual funds. You can purchase a single share of an ETF.
The major drawback of the ETF for the average investor is commission charges. If you are planning to buy only a few shares of an ETF at a time, you will have to pay commission every time you buy. So, even though you can purchase a small amount at a time, it is cheaper to pay with a lump sum. And if you were going to save up and pay a lump sum, you might just want to consider an open-end fund. This isn’t necessarily a deal breaker; just make sure to take commissions into consideration.
Even though they have been around for over a century, the closed-end fund is the least popular type of fund. I would venture to say that it is because people find them confusing or simply don’t understand them.
Unlike the open-end fund, which creates more shares with investor capital when needed, closed-end funds have a finite amount of shares available because, like ETFs, they create their shares during their initial public offering (IPO). Then the shares are traded on the market like ETFs and stocks.
The main difference between the ETF and the closed-end fund is that the value of closed-end funds is based more on the market. ETFs derive their market value from their net asset value. Also, closed-end funds are actively managed.
I, Benjamin Wey, have been an institutional investor for a long time. Even though mutual funds offer diversity and diversity lessens the chance of losing your hat, no investment is guaranteed. And there are so many types of funds that offer everything from a very diverse portfolio to a not-so-diverse portfolio. Of course, the more diverse, the less risk, but it also means less reward. There are ETFs and closed-end funds that fit into all of these categories. But certainly don’t rule out these alternatives to the open-end fund.