Difference Between ETF’s, Index Funds & Performance To Mutual Funds
Firstly ETFs, not many people know this but they don’t actually track the funds, they use a number of different methods to emulate the fund’s performance. They differ in index funds is that they are 24 hours a day and more liquid.
Defined as “security that involves a collection of securities — such as stocks — that often tracks an underlying index, although they can invest in any number of industry sectors or use various strategies. ETFs are in many ways similar to mutual funds; however, they are listed on exchanges and ETF shares trade throughout the day just like ordinary stock”.
Index Fund Explained
An index fund is a portfolio of stocks or bonds designed to mimic the composition and performance of a financial market index.
While an Index fund tracks the performance of the underlying index. Index funds can only be sold at the end of the day, while ETFs can are priced 24 hours and are liquid. ETFs are generally more expensive with the fees, and ETFs are priced on supply and demand rather than an index fund is based on the NAV (Net Asset Value) of the funds.
Mutual Fund Explained
A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets.
A mutual fund is normally actively managed and has a higher cost. It can have a range of assets in it, such as bonds, equities, and alternatives, such as property.
Which Is Better?
What is better, this debated over research, academics, and investment professionals alike have argued over this. The godfather of index investing John Bogle founder of Vanguard and author of many investing bestsellers states that passive investing that of an index is better than that of active management.
He has statistics on his side as well, if you look at the S&P over the last 35 years it has average 9.61% average and done an 8.64% over the last 40 years and 10% since inception. This has outperformed 93% of mutual funds in the short-run (10 years) and 98% in the long run. A Yale study says that you have 1/49000 chance of picking a fund that beats the S&P 500 over a 30-year time frame. Bogle, argues, that is nearly impossible due to manger changes, and other factors to beat in the long run. He has a point as well. He also disapproves of many rating agencies, saying that they only take into consideration the last 3 months not the long term performance so are not a true representative of the fund.
This is also represented by the godfather of investing Ben Graham, who states on probably the most famous book ever written ways to get average results would be to invest in an index fund.
Index funds were after Grahams time but he would approved to get average results.
This is emulated by his prodigy and the most famous investor of all time, Warren Buffet. When he did famously beat on Index funds Vs Hedge Funds
He says that you can’t beat the S&P, and emulates what Graham and Bogle stated. This going to say most hedge and mutual funds are not worth their fees.
But, saying that this is a man that has regularly out performed the S&P 500, so it is possible?
How does he do it? He uses Ben Graham’s approach with a twist, he looks for good quality stocks and invests for the long term, Buffet goes for more growth stocks than Graham, Graham was more a pure value investor.
But, his results speak for them self.
He has well outperformed the S and P 500 over the last 50 years.
The Average Fund
After going through academics studies in different periods the results were different. You have to acknowledge you can only compare like for like. That is you can’t compare a bond fund with the S&P 500 index. So only comparing large-cap equities stocks. What were the findings? 69.8% over a 10 year period failed to beat the S&P 500 in a meta-analysis, it has stated that in a bear market (in which the S and P 500 goes down) mutual funds have performed better with 3.7% higher performance than an index. But over any 15 year period even more in recent terms 91% from 2000–2015 have failed to beat any index funds this stating that only 9% do.
From the study, and looking at fees as well as an impact of the return you would be wise to have an index fund making at least some of your portfolio.
Personally, I have just changed my portfolio to go for one fund that I am confident with (I only have a hand full I really like) and the other into an S&P 500 tracker (60/40 split to the actively managed fund)
Why do I do this?
Well, I wanted to bring out some of the myths about large-cap index funds, people say they are not actively managed, I would somewhat disagree. Why? Well, look at the S&P500, which is the biggest 500 stocks by way of market capitalization. This means that if your market cap falls it doesn’t make it on the list and therefore only the biggest companies stay on the list. Look at the companies that were at 50 years’ age and see how different they were.
The picture below is what are the biggest companies in 1999
Here are the biggest companies as of last year
Only one company in the last 20 years has stayed in (Microsoft)
This is the same for the S&P500 it is always changing which means your index is as well.
I often get comments of, it’s not diversified enough geographically. I beg to differ. Look what the companies are, they are the biggest by way of market cap in the world, they approximately get 20% of their revenue from the U.S. where are Amazon, Proctor and Gamble, Johnson and Johnson all looking to go to increase their profits emerging markets. Many see the U.S as somewhat stale to increase their market share or profits margin while many see places like India, Vietnam, Brazil as much more exciting places to tap into the middle class or these future powerhouse countries.
Take, Amazon for an example of this. Where is it looking to go into India and will continue to grow out.
I would be carful, when picking mutual funds as statistically many do not beat the market and even less do over the short term. An index can be diverse and help you build that pot of money faster over the long term!