How I Will Be Rich

I have two separate accounts for investing. I have my IRA account and I have my discretionary account. In my discretionary account I mainly hold stocks and I typically practice the method that I explained back in my first attempt at investing advice. In my IRA account, however, I want to hold funds. I want that account to be less volatile and to steadily grow over the years. Holding index funds has been proven to return about 10% annually averaged out over several years. Lately I have been hearing a lot about something called ETFs or Exchange Traded Funds. I used to trade these in my discretionary account based on tips from various websites that I’d read. I knew that they mimicked various markets and that they were traded like stocks but that was about the extent of my knowledge. I’ve since done quite a bit of research and am in a much better place to discuss the differences between no load mutual funds and exchange traded funds.

Exchange Traded Funds
ETFs Can be traded like Stocks. The benefit of this is that you can quickly move in and out of them if you would like. You can essentially day trade or actively trade on the performance of an entire market sector, an index, such as the S&P 500, or the entire stock market for that matter. ETFs can also be bought on margin and sold short. The negative to this is that you have to pay any brokerage commissions associated with the trades. There is, however, a new discount brokerage called Zecco. I don’t know how new it is but I just discovered it a few days ago. By using this brokerage you can actually trade ETFs without a commission. However, if you read in to their pricing, they do have account maintenance fees for retirement accounts. So just be aware of that.

ETFs also typically have an expense ratio that is lower than the average mutual fund. This is very slight and typically shouldn’t be a big factor in the decision between mutual funds and ETFs. It just means that a little less money goes to the management of the ETF than in a mutual fund.

A negative aspect of the ETFs is that when you purchase or sell shares, you must pay half of the bid-ask spread. This is the difference between the market buy price and the market sell price of the ETF. This spread can be very large and makes it difficult to buy and sell in short periods of time. While this is good to know, it doesn’t really apply to someone who wants hold long term.

Mutual Funds (No Load)
Mutual Funds are traded at the price of the fund at the closing of the day that you bought in. If I bought into a mutual fund today, my brokerage would wait until the end of the trading day today and then purchase my shares of the fund at whatever that closing price was. Typically mutual funds also have a minimum amount of time that you have to have your money invested before you can sell, or else you will have to pay a penalty. One of the nice things about a mutual fund is that you can invest a dollar amount as opposed to buying a certain amount of shares. For example, I can purchase exactly $2000 worth of a mutual fund and it will get me something like 30.25 shares. This is especially beneficial if you are going to set up an automatic investment plan or if you plan to reinvest the dividends. If you want to reinvest dividends in an ETF, you are subject to whatever brokerage commissions apply every time.

For someone who plans to invest for the long term in a retirement account, I would prefer a No Load Mutual Fund. I think the two biggest factors that contribute to my decision are; 1. I can set up an automatic payment plan and I will not get charged commissions every time I add more money to it and 2. I can have dividends automatically reinvested without having to pay commissions and without having to wait to buy an exact amount of shares.

ETFs are, in my opinion, a little over hyped. Short term trading does not make too much sense due to the bid-ask spread issue and long term trading does not seem all the great due to all the commission fees you will end up incurring.

This is based on some of the research that I have done. If anything here is inaccurate or you have a different opinion (or you share my opinion for that matter). Please Please Comment!

Now get out there and set up a Roth IRA.

-M

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