Financial Analysis of Exchange Traded Funds

Warren Buffet said ‘Never depend on a single income.  Invest to create a second source.’  This is easier said than done, considering investing has a variable amount of risk associated with it.  Money used from the single income could be even smaller if the second source fails.  That is why mitigating risk is important and there are various investment options and vehicles to choose from to match the style and risk that can suit each individual.  Whether the goal is to invest for retirement, a second source, or even a primary source of income, Exchange Traded Funds, also known as ETFs, has the variability that can offer attractiveness to each type of investments.  Mutual funds and 401k have been a traditional vehicle for retirement investing for years due to its diversification and its ease to deposit money automatically from paychecks into its portfolio.  This analysis will compare ETFs with mutual funds and 401k’s and demonstrate the advantages and disadvantages of each.   Exchange Traded Funds are a great investment vehicle for the long term investor because the operating costs are relatively low, they offer diversification, and have better tax incentives than the traditional mutual fund or 401k plan, but it may not always be the best option. 

        It is important to important understand what a mutual fund, a 401k, and an ETF are.  A mutual fund is an investment where managers from investment companies such as Fidelity or Vanguard to invest pools of money from a group of investors on its behalf.  They provide diverse investments in stocks, bonds, and even cash without the investor to make several different purchases.  For an example, an individual would need to invest $100,000 in a diversified portfolio similar to a mutual fund and a mutual fund investor would only need to invest $1,000 to a fund (Kansas). 

        A 401k plan is a type of retirement plan offered by employers and since pension plans are becoming less popular, 401k plans have been the replacement to these.  A 401k plan can differ to employer to employer, but most 401k plans are consisted of mutual funds.  A major difference is 401k plans are tax-deferred where a mutual fund is not; although, the 401k is taxed when the money is taken out.  Also, 401k’s have a different operating cost associated with it.  For instance, if a 401k consists mutual fund “A”, the investor may pay more in operating costs than someone who just invests in mutual fund “A” separately (Nelson).  For sake of simplicity, this analysis will compare ETFs with mutual funds.