Know What you’re buying: Funds, Annuities, and ETFs — Ch 4 Bogle Head Series at Catch a Gideon

November 3rd, 2006 by digerati

This is the fourth part of the Bogleheads’ series here at Catch a Gideon. You can find the book (Bogleheads Guide to Investing) here.

Chapter 4: Know what you’re buying: Part Two

Mutual funds, funds of funds, annuities, and ETFs.

Mutual Funds

Mutual funds collect money from a lot of investors to buy stocks, bonds, or other investments. You buy a share which is a portion of the underlying assets the fund has purchased. There are a variety of types of funds with different investing objectives:

Aggressive growth funds
Growth funds
Growth and income funds
Specialty funds (like real estate investment trusts)

Bond funds can be separated by how long until their maturation: short(1-4 year), intermediate(4-10 years), and long(10+ years). Balanced funds invest in both bonds and stocks.

Fund Management Styles

Two main styles, active management and indexing. Active management funds actively trade stocks (or bonds, etc) to attempt to make a high return and outperform one of the benchmarks. Indexing funds instead match the proportions of stocks in their fund to that of a benchmark such as the S&P 500, Dow Jones, or Wilshire 5000. In practice few actively managed funds will outperform index funds in the long run. You learn about a particular mutual fund by reading its “prospectus.” It tells you the stock or other assets in the fund as well as the styles of investing and some information about previous returns.

Some advantages of investing in mutual funds:

Diversification - I’ve mentioned this as important before. With a mutual fund you automatically diversify because the fund holds many different assets.
Professional management
Low minimums - sometimes as low as $50 invested each month. More likely is a minimum of $1000-3000.
No-loads or commissions - Many funds let you buy directly from them with no sales commission charged.
Liquidity
Automatic reinvestment - the money generated could be automatically reinvested into the fund.
Convenience - buy them online, over the phone, or in the mail.
Customer service - questions can be answered quickly and easily.
Record keeping - you get statements showing activities and values as well as tax information.

You can also purchase funds that hold other funds as their assets. These are referred to as “funds of funds.” They can offer a mix of aggressive and conservative funds to create a perfect balance for you. Some of these funds will automatically change the ratios of their holdings for you based on your age or other criteria. This means you can buy the fund and not really need to change things again.

Annuities

Fixed annuities are a lot like a CD in that they pay a specific rate of return (maybe 4-6 percent) for a specified period of time on the money you put in. There are usually early withdrawal fees and you are often guaranteed a minimum rate of return.

Exchange Traded Funds

ETFs are like mutual funds that trade on an exchange. Most track an index, though a few are actively managed. The advantage of ETFs over mutual funds is their lower costs. The advantage (to some) is that ETFs are traded and repriced throughout the day. Mutual funds are usually reassessed at the end of a trading day. ETFs can be traded during the day and the exact cost can be calculated. This allows for more speculative trading, which of course the Bogleheads disapprove of.