A mutual fund is a professionally managed company that collects money from many investors and invests it in securities such as stocks, bonds and short-term debt, equity or bond funds and money market funds.
Mutual funds are a good investment for investors looking to diversify their portfolio. Instead of betting everything on one company or sector, a mutual fund invests in different stocks to try to minimize portfolio risk.
The term is typically used in the US, Canada and India, while similar structures around the world include the SICAV in Europe and the open-ended investment firm in the UK.
How to choose an ETF?
Just like other investments, choosing an ETF depends on the required asset allocation, financial objective, risk preference and time horizon. Choosing an ETF depends on the type of asset allocation you want to get in your portfolio by adding the ETF to it since ETFs are available for different types of asset classes such as stocks, bods, real estate, commodities. First decide on the asset class for the ETF.
Decide the type of diversification you want to achieve and the index you want to track. An ETF that tracks a broad market index is suitable for achieving maximum diversification with the least risk. If you are willing to take risks and want exposure to niche market segments, sectors or countries, choose a specific ETF.
Look at the ETF portfolio to understand the exposure it will give you. Choose ETFs with lower tracking error within the asset class and market segment you want to follow. Avoid poorly traded ETFs as they have wider bid/put spreads and will increase trading costs, reducing your ETF’s returns. ETFs that track a narrow market with lower levels of assets (AUM) tend to be less liquid and trade at a price that is not in line with their underlying NAV. Look for ETFs that tend to trade close to their NAV.