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Index Funds vs. ETFs

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When I first starting learning about investing in the Stock Market, I realized there was so much I didn’t know.  I was never exposed to the Stock Market by anyone in my family.  I became interested in the Stock Market after I read Rich Dad Poor Dad and a few other books on wealth strategies.

I began to play and learn with a little bit of cash.  I tried buying individual stocks and valuing companies.  I didn’t do bad, but didn’t do great either.  I found that I was spending lots of time researching and learning about companies, stocks, etc….  I was also trying to build my business and get it off the ground.  I was changing so many things in my life that after a couple years of investing and buying individual stocks, I decided I needed to focus on one thing at a time.  I had to make a choice.

My Choice

Since I could not focus on Stock Market investing and building my business at the same time, I chose that focusing on my business was most important.  It doesn’t mean that I don’t invest in the Stock Market.  I very much do…all the time.  But I don’t buy individual stocks any more.  I had to figure out how I could invest in the Stock Market and leverage the experience and time of others to be successful.  This is where I learned about Index Funds and Exchange Traded Funds (ETF’s).

Index Funds

These are funds that make up a segment of a market.  The market could be an industry, a bunch of large companies, small companies, or a variety of other combinations.  These funds allow you to own a broad piece of the market with lower operating costs and lower portfolio turnover.  They are a passive form of investing where you simply buy shares of an index fund.  The thought is that in the long run, the index fund will outperform any single investment.

Exchange Traded Funds (ETF’s)

ETF’s are baskets of securities that combine the benefits of stocks, mutual funds, and bonds.  They are sold on an exchange just like normal, individual stocks where prices change, throughout the day, based on supply and demand.

Index Fund vs. ETF’s

There are some significant differences between Index Funds and ETF’s.  Here are a few big ones:

1.  Index Funds cannot be traded throughout the day like regular stocks and bonds.  ETF’s can be traded throughout the day.  You have to wait until the end of the day to purchase or sell shares of Index Funds.

2.  Index Funds tend to require a higher minimum amount invested to own, whereas ETF’s have a much lower minimum requirement.  For example, I could buy a S&P 500 ETF with a few hundred dollars invested versus an Index Fund mimicking the S&P 500 requiring at least a $10,000 investment.

3.  Capital gains taxes are higher on Index Funds than on ETF’s.  There are some exceptions, but generally ETF’s are more tax efficient.

The Takeaway

Investing in the Stock Market can be scary and costly, especially if you don’t know what you’re doing.  Index Funds and ETF’s come to the rescue here letting you invest in securities that mimic popular markets and companies.  Both allow you the diversification of exposure that most wise investors recommend, are low cost, and typically provide strong long-term returns.  Though they have these similarities, the key differences are around the initial investment, when they can be traded, and tax efficiency.

I believe Index Funds and ETF’s are a great way to passively invest in the Stock Market and watch your money grow.  It’s their passive nature and leverage of other people’s time and experience that makes them attractive to me!!!

For the record, I am NOT a money manager or wealth advisor.  I only share my experience with you so you have some exposure and get some entertainment.  If you wish to invest in the Stock Market, I recommend you talk with a money management professional first.

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