In previous posts, we’ve talked about mutual funds and some of the details of how mutual funds work.  Now we turn our attention to a similar investment tool called exchange-traded funds (ETFs).

Exchange-traded funds are similar to mutual funds because in both cases the end result is a pool of securities that are owned by many different shareholders.  Both ETFs and mutual funds employ portfolio managers to manage the portfolio.  Both ETFs and mutual funds have both indexed and actively-managed funds.

How an Exchange-traded Fund is Created

An exchanged-traded fund is created by an organizer file the required paperwork with the Securities and Exchange Commission (SEC) which process is call registration.  Once the SEC has accepted the registration (remember, the SEC doesn’t ever approve an investment or investment product), the ETF organizer (sometimes called an ETF sponsor) basically trades shares for a basket (or portfolio) of securities that meet (or fit) the investment objectives of the ETF, as outlined in the ETF’s prospectus.  After the exchange, the shares of the ETF are allowed to trade on an exchange.  This creation process can be ongoing which allows the ETF to grow in size.

How Shares of an ETF are Bought and Sold

An investor can buy or sell shares of an ETF at any time during a trading day.  When an investor buys shares in an ETF they are buying those shares from another investor.  With trading throughout the day, the price of the ETF shares is constantly changing and an investor does not have to wait until the end of the day to buy or sell their shares.

ETF Advantage

For independent individual investors, an exchange-traded fund offers an investment tool that contains many different securities giving the investor the ability to gain diversification with very few investment dollars.  An exchange-traded fund also allows the independent investor to purchase shares in the ETF in very small quantities, even a single share.  This gives the independent investor the ability to purchase a single share in a large portfolio of securities.  Being able to buy a single share means the ETF may be the most accessible pooled investment tool available to the $100 Investor.

I like ETFs and find them very useful.

Other ETF topics that we’ll address in future posts include:

Costs of buying a mutual fund or ETF share

Annual expenses of mutual funds & ETFs

And here’s the necessary legal & compliance stuff:

Disclosure & Disclaimer

I am a practicing certified public accountant (CPA) and am licensed in the states of Oregon and Washington and own a CPA firm, CPA Worx LLC, and have practiced for more than 25 years.  I teach accounting at Oregon State University and have taught at the college/university level since 1997. 

I also own a registered investment advisory firm, Peacock Investment Worx LLC.  In the $100 Investor project, I am not offering recommendations of any kind nor am I providing tax, accounting, or legal advice.  I do not receive any type of compensation, of any kind, from the brokers, companies, mutual funds, exchange traded funds, websites, authors, publishers, investment managers, or anything or anyone else that I mention in this project.  True, my clients compensate me for my work and advice.  Many people do not want to invest on their own so I provide my investment services for a fee through Peacock Investment Worx LLC.  But the $100 Investor project is my way of helping anyone and everyone that wishes to invest on their own.  I want to support the independent investor.

Peacock Investment Worx LLC can be found online at www.peacockinvestmentworx.com and on Facebook at 100 Dollar Investor.

CPA Worx LLC can be found online at www.peacockcpaworx.com and on Facebook at CPA Worx.

The Mutual fund world is divided into two very different types of mutual funds: open-end mutual funds and close-end mutual funds.  The differences between the two types are significant.  The most important difference is center around how the fund’s shares are traded (purchased and sold by investors).

Creating A Mutual Fund

An open-end mutual fund is created by filing the required paperwork with the Securities and Exchange Commission (SEC).   Once the SEC has accepted the filing (FYI, the SEC only accepts filing and they DO NOT approve a filing) then the mutual fund may solicit money from investors for shares in the mutual fund.  Once the mutual fund has some money to invest they buy various securities that fit with the investment objectives of the mutual fund.

Buying and Selling Shares in an Open-End Mutual Fund

Open-end mutual funds are the most common form of mutual fund and is generally to what we refer as a mutual fund.

When an investor buys or sells a share in an open-end mutual fund, the investor is buying shares directly from the mutual fund and the investor is selling shares back to the mutual fund.  All the buying and selling of shares happens at the end of each business day (called a trading day).  Specifically, when an investor buys shares from a mutual fund the fund is issuing new shares to the investor.  When an investor sells shares back to the mutual fund the fund is redeeming those shares from the investor.  That means the total number of shares of the mutual fund is constantly changing because every trading day different number of shares that are issued or redeemed.

The price of the shares that are bought and sold each day is determined by the value of the securities owned by the mutual fund (aka net asset value or NAV).  When an investor buys shares of a mutual fund the fund will then invest those dollars into more securities that the fund owns in their portfolio.  When an investor sells shares in a mutual fund the fund will sell some of their securities to pay for those shares.  In many cases, the mutual fund will use incoming cash from shares sales to pay for the share redemptions and if any cash remains then that cash will be used to invest in additional securities.  This activity is often referred to as fund flows which describes the net amount of cash flowing into or out of a mutual fund.

Buying and Selling Shares in a Closed-End Mutual Fund

A closed-end mutual fund initially issues a fixed number of shares in the fund for investors to purchase which gives the closed-end mutual fund a fixed amount of capital to manage inside the fund.  When investors want to buy or sell shares in a closed-end fund, they trade those shares on the open market with other investors that are selling or buying shares in the fund.  This is a very different process from open-end funds.  With the shares of closed-end funds on an open market then the price of those shares are constantly changing during trading days.  The portfolio managers of closed-end funds also have the benefit of not having to issue and redeem shares each day which allows them to keep the fund’s capital invested.

Closed-end funds are priced based on both the fund’s net asset value (NAV) along with the supply and demand of shares available to trade as well as the expectations of investors.  All of these things combine to price shares of closed-end mutual funds that can be very different from the NAV of the shares.

So What

We, and most definitely the press, often refer to mutual funds without regard to specific funds and an independent investor should be aware that mutual funds can have some significant differences.  An investor must be aware of the differences so they can execute their plans by using investing tools that they understand.  If we want to write a letter and pick up paint brush, we won’t be successful in writing a letter.  Both types of mutual funds are very good investment tools but they can behave very differently and potentially create different results and we as independent investors must know our investment tools.

And here’s the necessary legal & compliance stuff:

Disclosure & Disclaimer

I am a practicing certified public accountant (CPA) and am licensed in the states of Oregon and Washington and own a CPA firm, CPA Worx LLC, and have practiced for more than 25 years.  I teach accounting at Oregon State University and have taught at the college/university level since 1997. 

I also own a registered investment advisory firm, Peacock Investment Worx LLC.  In the $100 Investor project, I am not offering recommendations of any kind nor am I providing tax, accounting, or legal advice.  I do not receive any type of compensation, of any kind, from the brokers, companies, mutual funds, exchange traded funds, websites, authors, publishers, investment managers, or anything or anyone else that I mention in this project.  True, my clients compensate me for my work and advice.  Many people do not want to invest on their own so I provide my investment services for a fee through Peacock Investment Worx LLC.  But the $100 Investor project is my way of helping anyone and everyone that wishes to invest on their own.  I want to support the independent investor.

Peacock Investment Worx LLC can be found online at www.peacockinvestmentworx.com and on Facebook at 100 Dollar Investor.

CPA Worx LLC can be found online at www.peacockcpaworx.com and on Facebook at CPA Worx.

What is a Mutual Fund

The term mutual fund is a common and widely-used term throughout many different media channels.  Mutual funds are used in retirement plans and are available to the investing public through traditional and online brokers.  So, what is a mutual fund?

A Combined or Pooled Investment

A mutual fund is a type of investment where many people pool or combine their money together for a professional investment manager to use to invest in individual stocks, bonds, and other types of securities.  Each mutual fund is governed by a prospectus which contains the rules about how the money in that specific mutual fund can be invested and what types of individual securities (stocks or bonds) may be held in the mutual fund.

Diversification

When an investor invests their money in a mutual fund they essentially own a small (usually very, very small) piece of all the investments owned by the mutual fund.  An investor can invest $100 into a mutual fund that owns stock in 500 different companies or they can invest their $100 in one or two shares of a single company (depending on the price of the shares).  This is called diversification when we can spread our investment across many different securities.  I think this demonstrates why mutual funds have become such a popular and useful investment tool.  For the same amount of money (our $100) we can purchase a piece of 500 different companies or a piece of one company – this is an example of how we can very effectively diversify our investments by using something like a mutual fund, even with very few dollars.

Professional Management

Along with the feature of diversification, mutual funds provide professional management by employing a portfolio manager whose job is to monitor the mutual fund’s investments, managing the process of buying and selling individual securities, and making sure the mutual fund is following its prospectus.  If the objective of a mutual fund is to invest in a specific index then the management of the investment doesn’t require much management because the mutual fund simply invests in the securities that are in the specific index.

While some mutual funds invest in a specific index, others are actively managed by portfolio manager (or a portfolio management committee or team).  We call these actively-managed mutual funds or active mutual funds (as opposed to passive or indexed mutual funds).  The portfolio managers in active mutual funds make investment decisions to buy or sell specific securities based on the objectives identified in the fund’s prospective and on their opinions about how they might generate better returns than a benchmark to which they compare themselves.  A benchmark is usually some type of index that is used as a standard to which the mutual fund’s results are compared.  The portfolio manager’s job in an active mutual fund is to generate higher returns that the benchmark to which the fund is compared.  We call this “beating the benchmark”.

Initial Investment Barrier

Although this example provides a simple demonstration of how a mutual fund works and the benefits investors receive from those mutual funds, we have encounter a barrier in real life that prohibits us from investing in a mutual fund with our first $100.  Almost all mutual funds require an initial investment for $2,000-$3,500.  As a $100 Investor who has been working to accumulate their very first $100 to invest, the mutual funds make themselves unavailable.

I Like Mutual Funds, But….

One of the original reasons that brought me to start this $100 Investor project was the dirty trick that mutual funds play on investors by requiring large initial investments which is very frustrating and extremely discouraging for a $100 Investor when they have worked to save their first $100 and are told it isn’t enough and that they need to save more.  Investing can be a daunting topic and can trigger subconscious fears and concerns that are challenging to recognize, let alone address.  For an independent individual investor to make a decision to start investing, work to gather their initial investment, engage in some self-education, and to open an account which leads to some excitement and anticipation then be told that you can’t invest in a mutual fund can cause a person to wonder why they went to the effort and trouble.

For the $100 Investor, mutual funds are very good investment tools (we sometimes call them investment vehicles) that can’t be used until later once a portfolio has a larger capital base.  I am a fan of mutual funds, especially mutual funds that invest in a specific index (many times called an indexed mutual fund).  I get frustrated with mutual funds because an investor needs at least $2,000 – $3,000 to invest in one, single mutual fund and an investor would need $36,000-$50,000 to be able to invest in a diversified portfolio of indexed mutual funds.

By necessity, the $100 Investor will not be able to use (or buy) mutual funds with their first $100.  Mutual funds are tools that will become available after an investor has built a larger portfolio or amassed a larger capital base.

We will talk about other important aspects of mutual funds in future posts which will include the following:

Mutual fund fees

Types of Mutual Funds: Open-end funds and Closed-end funds

Mutual fund share classes

How mutual fund shares are purchased or sold

And here’s the necessary legal & compliance stuff:

Disclosure & Disclaimer

I am a practicing certified public accountant (CPA) and am licensed in the states of Oregon and Washington and own a CPA firm, CPA Worx LLC, and have practiced for more than 25 years.  I teach accounting at Oregon State University and have taught at the college/university level since 1997. 

I also own a registered investment advisory firm, Peacock Investment Worx LLC.  In the $100 Investor project, I am not offering recommendations of any kind nor am I providing tax, accounting, or legal advice.  I do not receive any type of compensation, of any kind, from the brokers, companies, mutual funds, exchange traded funds, websites, authors, publishers, investment managers, or anything or anyone else that I mention in this project.  True, my clients compensate me for my work and advice.  Many people do not want to invest on their own so I provide my investment services for a fee through Peacock Investment Worx LLC.  But the $100 Investor project is my way of helping anyone and everyone that wishes to invest on their own.  I want to support the independent investor.

Peacock Investment Worx LLC can be found online at www.peacockinvestmentworx.com and on Facebook at 100 Dollar Investor.

CPA Worx LLC can be found online at www.peacockcpaworx.com and on Facebook at CPA Worx.

One of the first decision an investor must make is whether or not they want to invest on their own or use a professional.  If you are reading this, you have probably (or are at least considering very strongly) decided to be an independent investor and we should talk about what should be the next step.

The $100 Investor needs to develop themselves, their habits, and their finances to invest.

I’m a fan of the cartoon strip Calvin & Hobbs and find that both Calvin and Hobbs have both had moments of shear, unadulterated brilliance among pages and pages of insanity.  Calvin and Hobbs are at the top of a snow-covered hill, dressed in coats and gloves, with sled in hand.  They hop on the sled and are soon careening down the mountain side and headed toward a bump in the hillside that has been effectively turned into a jump.  Our heroes hurl down the hill and hit the jump sending them over trees to plant them in a spectacular heap.  Hobbs turns to Calvin and asks something like “maybe we should have packed a parachute”.

As kids, we may have found ourselves whisking down a hill of decision that ended and spectacular mess as the decision we made provided us the jump to launch us over the trees.  As we grow up and have more life experiences we learn more and more about evaluating options and developing our capacity to make better decisions.  I think that we need to do the same thing specifically for our financial and investing selves.

The starting point for the independent, $100 Investor is to gather $100.  That means very different things for each person reading this post.  For those who are young it may mean finding an odd job or two to earn some extra income to gather $100.  For those that are into their working life it may mean changing some buying habits to eliminate unnecessary purchases to gather $100.

In any case, the $100 Investor should be in control of their spending and start developing the habit of planning for future needs and wants.  So what does that entail?  That means the $100 Investor should know how much money they are making, how much they are bringing home, and when that money will arrive at home.  It also means that the $100 Investor knows how much he or she spends and for what they spend their money.  The key to becoming a true $100 Investor is making the conscious, informed decision to change some spending habits or create additional income for the express purpose of investing.

I have long known that controlling spending is an important habit but I haven’t developed that habit.  I didn’t develop the habit when I was young and first starting to earn my own money and that lack of habit continued as I graduated from college and began a career.  A habit must be developed and that means the inertia of one’s live must be changed and redirected.  I have been working on changing my habits and developing the habits I want and the process gets harder and harder as time passes and the old habits are more practiced and more ingrained.

Our challenge is that we don’t learn to understand and manage money in school or at home.  Our society in the United States is built on the desire to spend and consume now.  For me, I didn’t learn how to tune out the consumption-oriented messages and ignore the hype to buy stuff.  In high school I worked to buy the new snow skiis and boots that arrived in September, to get tickets to the just-announced concert coming to town, to go see the latest movie on opening weekend, and a myriad of other things for which my desire to own or purchase were fanned by advertisements, commercials, magazines, shows, and all the other “BUY” messages which bombard us every day.

Investing is simply this……delaying our desire to spend & consume from today to some point in the future.

To start, as a $100 Investor (no matter where me are right now in our personal and professional careers), I need to find $100.  Even if we don’t have the greatest budgeting skills or the strongest resistance or impulse buying, I think we need to find $100 and invest it, as soon as possible.  For me, this approach has given me a reason and a tangible tool to help me resist impulsive purchases, to better evaluate purchases, to motivate me to be willing to work within a budget.  I have many years of ineffective and unprofitable habits which I need to change and gathering my first $100 has been a tremendous counterbalance to my ingrained habits.  Now my wife would tell you, if you were to ask her today, that I still have a long way to go but that I have made some progress.

Now go get your first $100.

Put the money into a savings account as you gather your funds.  As you get close to your $100 goal, the next step will be to evaluate and choose a broker to use for your investments.

Disclosure & Disclaimer

 I am a practicing certified public accountant (CPA) and am licensed in the states of Oregon and Washington and own a CPA firm, CPA Worx LLC, and have practiced for more than 25 years.  I teach accounting at Oregon State University and have taught at the college/university level since 1997. 

 I also own a registered investment advisory firm, Peacock Investment Worx LLC.  In the $100 Investor project, I am not offering recommendations of any kind nor am I providing tax, accounting, or legal advice.  I do not receive any type of compensation, of any kind, from the brokers, companies, mutual funds, exchange traded funds, websites, authors, publishers, investment managers, or anything or anyone else that I mention in this project.  True, my clients compensate me for my work and advice.  Many people do not want to invest on their own so I provide my investment services for a fee through Peacock Investment Worx LLC.  But the $100 Investor project is my way of helping anyone and everyone that wishes to invest on their own.  I want to support the independent investor.