Mutual Funds for Diversification
Mutual funds can be found to suit any investment objective and type of investment. A study of performance in all kinds of markets is an important step in selecting a fund.
The traditional mutual fund can be bought and sold only by communicating directly with the fund's management. Value of a share of a mutual fund is determined at the end of the trading day only. In comparison, an ETF can be bought or sold on the public exchanges, and value changes during the trading day just like stock.
One great advantage to the ETF beyond its high liquidity is that it identifies its components in advance, meaning the management of the fund is virtually automatic. Mutual funds charge for managing a portfolio and once you buy shares you have little to say about the buy and sell decisions management makes. In an ETF, you know in advance what is in the fund. This is an advantage because it gives you automatic diversification; it is also a disadvantage because the return on an ETF is going to be the average of all its components. For example, if an ETF holds 10 stocks in one sector, of which three outperformed the others, the overall return is going to be equal to the average of all 10, not of the three outperformers.
ETFs exist for a variety of defined groups, including:
- Specific sectors or industries
- Stocks of specific countries or regions
- Shorts (ETFs that sell components instead of buying)
- Emerging markets
- Debt instruments, including fixed-income ETFs
- Real estate
Exchange-traded funds are the hot new kind of mutual fund. They off er many advantages, but these are no guarantee that ETFs will always outperform the traditional fund.