How to Pick a Mutual or Exchange-Traded Fund (ETF)

Author: James Clark

Choosing Between Mutual and Exchange-Traded Funds

New traders come across two major types of funds – mutual funds and exchange-traded funds. These two fund types are quite similar as they offer traders an inexpensive option to diversify to retirement. However, there’s a big difference between how these two funds are managed and traded. So, you need to learn how to pick a mutual fund or exchange-traded fund before deciding which one suits your trading style better.

Read on to learn more!

What Is a Mutual Fund?

A mutual fund is a collection of securities, including stocks, FOREX, and bonds that provides traders with an optimal long-term or short-term investment opportunity, such as saving for retirement, buying a house or car, starting a business, etc. With mutual funds, you can invest in various securities, such as government bonds, fixed income bonds, and company shares all in a single package.

How to Pick a Mutual Fund

Deciding which mutual fund topic can be a bit overwhelming due to so many potential options and combinations. Traders looking to evaluate funds individually to build a diversified investment strategy, generally use 3 key criteria to narrow their options:

1. Trading Strategy

Traders devise a strategy according to their financial situation, goals, risk tolerance, and timeline. So, it only makes sense to combine stocks, bonds, and other securities into your mutual fund accordingly. This will help you diversify your trading portfolio with different risk profiles, types of stocks, and investments.

2. Performance

When choosing a mutual fund, most traders use past data to evaluate or anticipate performance. However, markets are always changing so future results aren’t guaranteed. High-performing stocks can fall or poorly performing funds to improve.

3. Costs

Cost is one of the most important considerations in trading. Before choosing a mutual fund, estimate its expense ratio. This includes the management fee (Fund Company), 12b-1 distribution fee, and other expenses.

What Is an Exchange-Traded Fund?

An exchange-traded fund (ETF) is quite similar to regular stock, meaning you can exchange it on your trading platform. ETFs allow traders to exchange a basket of assets within a specific sector and diversify their portfolios with varying levels of risk. They contain several types of investments, including currencies, commodities, stocks, bonds, and others.

How to Pick an Exchange-Traded Fund

Like mutual funds, there are thousands of ETFs to choose from for traders, which makes it just as difficult. So, here are 3 key criteria for choosing ETFs:

1. Level of Assets

Any ETF you choose should have a minimum level of assets, generally at least $10 million. Anything below that generally doesn’t capture the interest of most traders. With limited investor interest, you have poor liquidity.

2. Your Trading Activity

Before finalizing an ETF, check how much it’s being traded every day. It’s better to choose ETFs that have high trading volumes. Some even have millions of shares daily. The rule remains the same. The higher the trading volume, the more liquid it’s likely to be.

3. Market Position

In the ETF world, you need to emphasize the first-mover advantage, meaning you have to be as original as possible and avoid ETFs that are imitations of other ideas.

Bottom Line

By learning how to pick a mutual fund or exchange-traded fund, you can reduce your trading risk by looking under the hood at what each option has to offer. They might rank among the most inexpensive fund types in the market, but that doesn’t mean they’re cheap. However, they will give you broad market exposure and diversify your trading portfolio.

For more information on the stock market and trending industrial practices, we recommend subscribing to the PT Premium Service in the Proficient Trader App