What is the value of various asset classes? Understanding the differences between ETFs, mutual funds, proprietary funds, and stocks

Have you ever wondered where to begin with investing? There are so many different types of investments, and prospective investors can end up spoiled for choice. Some of the most common instruments available are exchange-traded funds (ETFs), mutual funds, stocks, and proprietary funds. Understanding each of these, and their unique advantages and disadvantages, can help you make an informed decision about which might be best for your unique financial situation.

What are ETFs?

ETFs hold a basket of securities. This means that they have already done some of the work of diversification for you. While there are numerous ETFs, the majority track indices, commodities, or publicly traded equities.

Much like stocks, ETFs can be traded throughout the day. They are traded on stock exchanges, offering investors flexibility and liquidity.  

ETFs are also very transparent. Most ETFs disclose their holdings daily; this makes it easy for investors to know what they own. For those who are interested in a specific sector, this can be an advantage.

ETFs may incur brokerage commissions with each trade that is placed, eating into your profit margins. Because they are traded on stock exchanges, they, like stocks, are subject to market fluctuations. ETFs also tend to be passively managed.

What are mutual funds?

Mutual funds, like ETFs, are a type of fund. A key difference is that, unlike ETFs, which are passively managed, mutual funds are actively managed by portfolio managers. These funds are designed to achieve specific outcomes, such as capital preservation, income and growth.

Mutual funds share many of the advantages of ETFs. They are diversified across assets, and there are numerous funds available for investment depending on your needs.

They are not, however, as liquid. Unlike ETFs, mutual funds can only be traded at the end of the trading day. They must be bought and sold at the Net Asset Value (NAV).  

Mutual funds also usually charge management fees. Because this type of fund is actively managed, the management fees come out of your net returns. This, coupled with potential brokerage commissions, can reduce your overall profit margins.

What are proprietary funds?

Proprietary funds are created and managed by financial institutions. Banks and brokerages will create these funds for their own clients and are often available only to clients of those institutions.

These funds are often created to meet specific client needs. Although not individualized, they may represent the needs of the majority of clients. They are also incredibly easy to access because they are integrated with your financial institution. Often, you can see your investments alongside your savings and checking accounts.

Unfortunately, because these funds are created and managed internally, advisers may have internal incentives to prioritize these funds—even if they are not in your best interest. The holdings may also not be as transparent as ETFs or mutual funds.

What are stocks?

Equities are probably the asset class you have heard the most about. When most people think about investing, they think about stocks—or at least the stock market.

Stocks represent ownership in a company. When you buy a share of stock, you own a (usually very small) piece of that company. As such, you have a claim on its assets and profits. Stock prices fluctuate based on supply and demand, the overall performance of the company, and market conditions.

A major advantage of stocks is that they are liquid. They can be easily bought and sold on most online trading platforms, such as banking apps like SoFi and investment apps like Robinhood. Stocks can offer the potential for strong returns, but they can also be volatile. Just as it is not unheard of for stocks to experience remarkable returns, it is also not uncommon for stock prices to suddenly plummet, leaving investors with a tiny fraction of their money.

Researching individual stocks requires time, effort, and a solid understanding of the market. For many investors, this is why funds that are diversified and managed may be a better fit. For savvy investors with market knowledge, though, individual stocks can be rewarding.

Which is right for me?

Although it is always best to speak with a financial adviser who understands your unique situation, there are a few guiding principles.

If you want flexibility and relatively low-cost diversifications, ETFs may be right for you.

If you want professional management and diversification and don’t mind paying management fees, mutual funds may be a good fit.

If you want all your finances in one place and don’t want to know every detail about your investments, proprietary funds might work well for you.

If you want high growth and are comfortable with high risk, you might consider investing in individual stocks.

Whatever you choose, be aware that there are risks associated with each asset class. A qualified financial adviser, like our team members here at GDS Wealth Management, are here to help guide you based on your unique financial situation and goals.