When you retire, would you rather move to a nice beach-front property and spend your days watching the sunset fade out over the ocean from your breezy balcony, or move into the retirement center and play bingo every night?
The decisions you make now will greatly effect which option is available to you.
Many graduates will soon be faced with the daunting task of saving for retirement, and those without a finance degree will probably be looking for the easiest way to invest and save.
There are options out there for the na’ve investor, but depending on which option you choose can affect your standard of living after you finally call it quits years down the road.
The debate comes down to two options for novice investors: ETFs or mutual funds. The differences to the novice investor may seem subtle, but one can cost a vast deal more and sap retirement savings.
The rundownExchange traded funds, or ETFs work on a basic principle. A company will choose an index to invest in, whether that is the S&P 500 (the benchmark index) or more specific indexes focusing on sectors, such as energy, financials, technology, etc. The company will then choose companies within the said index and buy shares representing a broad spectrum of companies within the index.
From there they turn all those shares of different companies into one product for investors to buy and trade on the open market. In essence, the investor can invest in a stock that invests in a bunch of stocks. For example, by buying one share of an S&P 500 index ETF, you have essentially just purchased a very small portion of stock from 500 companies.
The rival product is what is known as a mutual fund. These are funds run by stock pickers that in theory can pick the winner stocks and shed the losers that an indexed fund would be forced to hold. So in effect, it is similar to an ETF but it is actively managed, meaning there is a manager constantly buying and selling within the fund to achieve better returns. The catch: you have to pay fees for the manager to manage your money.
The catchThe advantage of ETFs is two fold. They can be bought and sold on the open exchange just like stocks, making them more liquid if you wanted to move your money into a different area. ETFs generally have much lower fees than mutual funds, which can make a substantial difference to returns over time.
For example, imagine a saver with an account of $20,000. If it were invested in an ETF with an annual fee of .5 percent (most are less than this), and he allowed the money to grow at an average rate of return of 7 percent, he would have about $70,500 by the time he was 65 if he made no other contributions.
If he had invested in a mutual fund with a fee of 1.5 percent annually (many are higher than this, reaching up to 3 or 4 percent) his return would only be a little more than $58,000.
The bottom lineMutual funds offer advantages of lower transaction costs for putting your money in (however brokerages commission fees are decreasing), but all returns are subject to the higher fees. True, a few of the stock pickers will beat the market, but many fail to do so and still charge you fees on top of that.
For the beginner saver, ETFs are a viable option to rival mutual funds and would make for a good mix to reduce the overall fees in your retirement portfolio.
