There are literally thousands of funds available to investors today. There are various ways that the industry classifies those funds and today I wanted to explain the key differences between Mutual Funds, Index Funds and Exchange Traded Funds (ETFs).
An investment fund is an investment product created with the purpose of gathering investor’s capital and investing that capital collectively through a portfolio of financial instruments such as stocks, bonds, and other securities. For today’s discussion, we will focus on funds that invest in stocks.
A stock fund is an investment product that includes a portfolio of individual stocks. Most stock funds contain at least 20 individual stocks and often own as many as 100 individual stocks in the fund.
There are two aspects of funds to help us understand some of the differences. The first aspect is how often the price of a fund is calculated and that influences how it can be traded. The second important aspect is how the stock selections are made in the fund.
Mutual funds have been around the longest and, therefore, that term is more well known to people. The key difference for mutual funds is when the fund can trade and when it’s Net Asset Value is calculated. Mutual funds can only be bought and sold at the end of the trading day which is when the fund’s Net Asset Value is calculated.
The closing price of each stock in the mutual fund is used at the end of the trading day to calculate the weighted average price of the mutual fund – the Net Asset Value. Since an accurate price is only known at the end of each trading day, it is not possible to establish a fair price for trading during the day.
An Exchange Traded Fund (ETF) can be traded during the day because its price is calculated in real-time throughout the trading day. High speed computers are needed to make these ongoing calculations throughout the day. Because a current market price is calculated throughout the day, buying and selling shares in an ETF is much more efficient and flexible than mutual funds.
An index fund can be a mutual fund, or it can be an ETF. Most index funds that we recommend are of the ETF variety. So, an index fund is not different because of the way it trades or how its price is calculated. An index fund is different than other funds because of the way that the stock selections are made inside the fund.
An index fund’s investments are driven by the index that the fund is designed to track. For example, I talk a lot about S&P 500 index funds. The S&P 500 index is a list of the biggest 500 companies that trade on the US stock exchanges. An S&P 500 index fund owns all of the stocks in the S&P 500. S&P index funds are managed by a computer and not a fund manager. There are no investment decisions for index funds. They simply use computers to keep track of the changes of all of the stocks in the index to arrive at a price for the fund – its Net Asset Value.
Let me provide an example of how these definitions impact your trading. Let’s say you want to sell $20,000 worth of a money market fund that you own and you want to use that $20,000 to buy shares of an S&P 500 index fund which is an ETF. Money market funds are mutual funds, so they can only be traded at the end of the day. During the first trading day, you would need to sell the $20,000 in the money market fund. You would have to wait until the second trading day to buy the S&P 500 fund because the cash would not be available from the sale of the money market fund until the next trading day.
If you have a 401K account, all trades are handled by the account administrator and are most often executed on the second trading day after you submit your changes to your investment allocations. So, for 401K accounts, you don’t have to worry about any of the timing of the trades or the Net Asset Value calculations.
Stay Disciplined My Friends,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
Stocks have rebounded nicely in the last three weeks. Both the S&P 500 and the Nasdaq are now at new all-time highs.
Between November of last year and the third week of March this year, the S&P 500 and the Nasdaq (top two lines) moved sharply higher. All three major stock indices pulled back in April and rebounded in May.
Inflation data, interest rates and recession concerns continue to drive the markets in both directions. Even slight changes in inflation are generating strong reactions from the market. I find it to be surprising that a 0.1% change in the inflation reading generates such a strong reaction from the stock market. I doubt that the inflation data is even accurate to one tenth of one percent.
Our valuation model is now showing that the S&P 500 is slightly overvalued after the big runup since last November. As of May 1st, our Market Value Indicator suggested that the S&P 500 was about 3% above its fair market value. That has increased to about 8% so far in May. This level of overvaluation is not very concerning, but we will keep an eye on it.
Notice that the S&P 500 was overvalued by about 16% before stocks began to fall in January of 2022. It was not just inflation and interest rates that contributed to the bear market of 2022.
We do not use Market Valuation as a trading variable. It is not very useful in the short term. It does have value for the long-term direction of the market.
Stay Disciplined my Friends,
Phil
Disclaimers *The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
The IRS changes the 401K and IRA rules periodically, so I like to review them once a year for our followers. In today’s post, I will be focusing on the rules for Required Minimum Distributions or RMDs.
Required Minimum Distributions (RMDs) are minimum amounts that IRA and retirement plan account owners generally must withdraw annually starting with the year they reach age 72 (73 if you reach age 72 after Dec. 31, 2022).
Required Minimum Distributions (RMDs) are an essential element to consider when planning for retirement with retirement accounts such as 401(k)s, IRAs, and other tax-advantaged savings plans. Understanding the rules surrounding RMDs is crucial to avoid penalties and make the most of your retirement savings.
You generally must start taking withdrawals from your traditional IRA, SEP IRA, SIMPLE IRA, and retirement plan accounts when you reach age 72 (73 if you reach age 72 after Dec. 31, 2022). The RMD rules apply to all employer sponsored retirement plans, including profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs.
The RMD rules do not apply to Roth IRAs while the owner is alive. However, RMD rules do apply to the beneficiaries of Roth 401(k) accounts.
Account owners in a workplace retirement plan (for example, 401(k) or profit-sharing plan) can delay taking their RMDs until the year they retire, unless they're a 5% owner of the business sponsoring the plan.
This minimum withdrawal is based on your life expectancy and the total value of your retirement accounts. Generally, a RMD is calculated for each account by dividing the prior December 31 balance of that IRA or retirement plan account by a life expectancy factor that the IRS publishes in tables.
Failure to take out the required minimum distribution can result in a hefty penalty—50% of the amount you should have withdrawn but didn't. You can withdraw more than the RMD in any year. But a withdrawal in excess of the RMD in one year cannot be applied to the following year.
It's important to plan ahead for RMDs as they can have tax implications. The rules surrounding RMDs change frequently. The withdrawn amount is generally subject to income tax, so it's essential to consider how these distributions will impact your overall tax situation in retirement.
Overall, staying informed about RMD rules and requirements is key to successfully managing your retirement savings and ensuring you make the most of your hard-earned money in your golden years. Be sure to consult with a financial professional to help you navigate the complexities of RMDs and tailor a plan that suits your individual retirement needs.
Stay Disciplined My Friends,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
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