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Deciding on the mutual funds or ETFs you want

There are funds for every kind of investor. Here's how to find the ones that are right for you.

POINTS TO KNOW

  • All-in-one funds give you a complete portfolio in a single fund.
  • Funds either track a benchmark index—like the S&P 500—or are actively managed.
  • There are 2 kinds of funds: mutual funds and ETFs. They're similar but trade differently.

Want to make this simple? We can help

Investing for retirement?

A target-date fund can make investing easier. Find the right fund based on your approximate retirement date, and the fund will invest in an appropriate asset allocation, then modify the mix as time goes by so that your risk gets lower as you draw closer to retirement.

Investing for something else?

Some funds let you choose a risk "flavor" (like conservative, moderate, or aggressive). The fund then invests in an appropriate asset allocation and maintains that mix.

Or get an asset allocation recommendation online in just a few minutes. Simply answer some questions about your time frame, risk preferences, and financial situation.

Want to create your own portfolio?

If you'd like to choose mutual funds or ETFs on your own, there are a few more decisions you'll need to make.

Index or active?

First, you need to decide what type of investment strategy you prefer.

  • Index funds stick as closely as possible to the returns of a specific market segment, as measured by a benchmark index.

    For example, an index fund tracking the Standard & Poor's 500 Index will own all of the stocks (or a representative sample) included in that index. Its return will be close to the return of the S&P 500, although costs may cause it to lag somewhat.

    What's the benefit of just tracking an index rather than trying to beat it? Well, because the fund doesn't have to pay a manager to select specific securities to buy and sell, costs are generally low.
  • Active funds have managers who select the stocks or bonds that the fund buys and sells. Managers may make their selections based on in-depth research, analysis of the stock's or bond's characteristics, or both.

    Investing in active funds gives you the opportunity to earn more than the average market returns. But active funds do come at a higher cost.

Keep in mind that this isn't an all-or-nothing decision. Many people start with a core portfolio of index funds and then add active funds for certain segments of the market.

Go in-depth with these white papers

Read why 5 things you may have heard about indexing aren't necessarily true.

See the 3 elements that can help fund managers win in the active space.

Learn whether market conditions have a greater impact on the success of active managers than talent or costs.

Find out why we believe that excess return in "smart beta" strategies can often be explained by size and style tilts.

Mutual funds or ETFs?

If you decide on an index strategy, you'll also need to decide what kind of funds you want to invest in.

  • Mutual funds own a portfolio of stocks or bonds, and they're priced at the end of each day, based on the closing prices of every security owned by the fund. When you buy or sell mutual fund shares, the price you'll pay or receive is that night's closing price.
  • Exchange-traded funds (more commonly known as ETFs) also own a portfolio of stocks or bonds, but shares of these funds trade on an exchange, like stocks, with constantly shifting prices.

    Unlike with mutual funds, the current price of an ETF share isn't always perfectly aligned with the values of the underlying investments. However, for ETFs that are very liquid, these values tend to stay very close.

Go in-depth with these white papers

Read about the factors that play into your choice between mutual funds and ETFs.

Learn why ETFs are an attractive and efficient way to implement an investment strategy.

See why we believe that ETFs that track non-market-cap-weighted indexes are really just a form of active management—one in which you become the active manager.

Fund ratings: A surefire way to pick?

Many people wouldn't dream of making a major purchase without checking product ratings. In fact, some people make decisions based solely on ratings.

So when you hear about fund ratings, it may seem like the best way to choose your funds: Just buy the ones with the most stars.

But be careful. Most fund rating systems rely heavily on the funds' recent performance figures—which would be fine if a fund's past performance told you anything about its future performance.

Generally, however, it doesn't. In fact, based on past history, a recent streak of great performance suggests that a performance lag may be in the future.

We don't display any kind of fund ratings on our website, but it's fine to check out a fund you're considering to see how it's rated and why. Just make sure you don't use ratings as the sole basis for your decision.

How should you choose investments?


WATCH AND LEARN

Being "average" can be pretty great! See how indexing works—and why it works so well.

Can you take on the market ... and win? Hear our thoughts on whether active managers can successfully beat the market.

Read a transcript

Indexing is only for stocks ... right? See why indexing isn't just a viable strategy for bond investments—it's a great strategy.

Read a transcript

A fund by any other name ... See how ETFs and mutual funds are similar—and how they're different.

Read a transcript

Volatility, or flexibility? Our experts explain what to consider when deciding on a type of fund.

Read a transcript


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REFERENCE CONTENT

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Asset allocation

The way an investment portfolio is divided among various asset classes, such as cash investments, bonds, and stocks. Also known as "investment mix."

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Risk

Usually refers to investment risk, which is a measure of how likely it is that you could lose money in an investment. However, there are other types of risk when it comes to investing.

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Conservative

A conservative portfolio is relatively safe from investment risk (although there's no guarantee it won't lose money). Because risk and reward are related, a conservative investor can also expect returns that are, on average and over time, lower than those of someone with a moderate or aggressive portfolio.

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Moderate

A moderate investment is neither very aggressive nor very conservative. Because risk and reward are related, a moderate investor can expect returns that are, on average, neither very high nor very low.

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Aggressive

An aggressive portfolio is subject to a relatively high level of investment risk. Because risk and reward are related, an aggressive investor can also expect returns that are, on average and over time, higher than those of someone with a moderate or conservative portfolio.

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Index

An unmanaged group of securities whose overall performance is used as a benchmark. An index may be broad or focus on one sector or type of security.

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Stock

Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.

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Returns

The profit you get from investing money. Over time, this profit is based mainly on the amount of risk associated with the investment. So, for example, less-risky investments like certificates of deposit (CDs) or savings accounts generally earn a low rate of return, and higher-risk investments like stocks generally earn a higher rate of return.

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Bond

A bond represents a loan made to a corporation or government in exchange for regular interest payments. The bond issuer agrees to pay back the loan by a specific date. Bonds can be traded on the secondary market.

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Share

A single unit of ownership in a mutual fund or an exchange-traded fund (ETF) or, for stocks, a corporation.

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Exchange

A marketplace in which investments are traded. The exchange ensures fair and orderly trading and publishes price information for securities trading on that exchange.

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Performance

The measure of how much an investment has paid off, also known as return.

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Can actively managed funds outperform the market?

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Can actively managed funds outperform the market?

Liz Tammaro: Great. So we actually have a second live question here from Chris. So Chris says he understands that not all, or even most, actively managed funds can beat the market—we talked about that—but do we believe that a small percentage of particularly skilled managers could consistently beat the market or the market averages or indexes? And if that is true, if someone were able to have consistent outperformance, would it be worthwhile to research and find those managers versus using index funds? What do you think?

Scott Donaldson: Sure, I'll try to take a stab at that. I mean, if you think about it, if you certainly know or you think or have a high level of confidence that you're going to select a manager that can outperform the market, or you know with certainty they're going to outperform the market, then you would actually choose to do that.

Liz Tammaro: Sure.

Scott Donaldson: The difficulty of that is in a lot of the research we've seen is even though there have been active managers that have been successful and been able to outperform the market, over even whether it's one, three, or even in some cases ten years or more, that outperformance is very, very difficult to maintain because of some of the differences in the portfolio holdings and the characteristics of the market. The characteristics of what are in favor change from time to time based on the economy and earnings outlooks and so forth.

So unless that manager believes in a style that is an outperforming style for a while, they usually just don't all of a sudden change that philosophy as market conditions change. Some do, but many, many don't. So there's going to be a time when they're probably going to outperform sometime in the future.

One of the pieces of data that we have seen if you're going to select an active manager, it's certainly having confidence in the team and their philosophy, and you believe in it, and how well have they done over how long, and so forth. But the other thing, similar to why indexing, is a very positive and good investment strategy is low costs—or lower-cost relative to higher-cost funds—are one of the best predictors of future relative outperformance, or performance that we have seen in our research. Morningstar has done the research. There's numerous studies out there that lower costs are one of the best predictors.

So if you're going to go active, looking at lower-cost active relative to a higher-cost active counterpart is a very, very good starting point to do that.

Walter Lenhard: We should also mention that although Vanguard is a big believer in index products, we also believe in active management. So the markets aren't perfectly efficient, and there should be the ability to capture some positive excess return. You just have to be very careful about the mean reversion. A lot of managers that have outperformed over the last three and five years don't outperform over the next three- and five-year cycle.


For more information about Vanguard funds, visit vanguard.com, or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

All investing is subject to risk, including possible loss of principal.

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

© 2014 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.

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Does index fund investing work for bonds?

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Does index fund investing work for bonds?

Liz Tammaro: So, Scott, I'm going to stick with you. We have another live question. This is coming from Harry and he says, "What about bonds? Does indexing work as well with bonds as it does with stocks?"

Scott Donaldson: Yeah, it's funny—and this is probably one of the questions I receive the most on—and we're talking about the benefits of the indexing strategy. And if you think about it, we heard the positive performance numbers against active managers on the equity side. But on the bond side, usually the question comes out a little bit from the aspect of the transparency of the bond market is viewed as a little bit less. It's viewed, in general, maybe as a little more "less-efficient market." So the belief is that there's greater opportunity for active managers to possibly take advantage of some of that lack of transparency and liquidity and so forth.

But it's interesting because indexing, relative to say an actively managed portfolio, is even more powerful on the fixed income side than it is on the equity side. So you heard the numbers of 70% of active managers underperform on the equity side over the long term. If you look at the bond market and the fixed income products over the last 10 or 15 years, that number jumps to 90% of active managers underperform their corresponding passively managed benchmark.

Liz Tammaro: Wow!

Scott Donaldson: And if you think about the reasons why, okay, there's a couple. One, remember how important, we talked about costs. Okay?

Liz Tammaro: Right.

Scott Donaldson: If you have a 0.5% annual fee on an equity fund that's returning 10% a year, that's not that significant, right? But if you now have that same 0.5% annual expense ratio on a bond fund that in today's yield environment is now somewhere between 2% and 3%, that 0.5% annual fee is a much larger chunk of cost that's eating up that return. So indexing as a low-cost investing alternative is very, very successful in capturing as much of the return as possible.

The other reason, I think, is really bonds, in general, are less risky than stocks; they're not as volatile. There's less characteristic differences in the bond market between a corporate bond and another corporate bond, or a treasury bond and another sovereign bond, say in the U.K., or whatever the bonds you're comparing. It's hard for the active manager to truly differentiate themself that much from the index to try to achieve the outperformance. Therefore, keeping a low cost on indexing relative to the market benchmark is a very, very successful strategy.

Liz Tammaro: Yes. So what I'm hearing you say is, again, costs matter and indexing can work well for both asset classes.

Scott Donaldson: Absolutely. Absolutely.


For more information about Vanguard funds, visit vanguard.com, or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

All investing is subject to risk, including possible loss of principal.

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

© 2014 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.

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ETFs 101

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ETFs 101

Liz Tammaro: So, we received quite a few questions in advance when you all registered for this webcast. We're going to get started with our first question and Jim, I'm going to give this one to you. So it makes a lot of sense before we get started, let's define what is an ETF.

Jim Rowley: Simply put, an ETF is an exchange-traded fund, right? It's a pooled investment vehicle that acquires or disposes of securities. Investors own a pro rata share of the assets in that fund. The fund issues new shares or redeems existing shares to meet investor demand.

Furthermore, and I should say providing some type of an investment exposure to those advisors, whether it's an index in particular or a market strategy. And when you think about even more so what makes them similar to mutual funds is that the majority of ETFs are organized and regulated as investment companies under the Investment Company Act of 1940. And that's the same regulatory regime under which mutual funds operate. So for all the discussions sometimes we hear about differences between mutual funds and ETFs, they're overwhelmingly similar, actually.

Doug Yones: Yes, and I think about your first point, Jim, exchange-traded fund. We are talking about a fund, but there's a wrapper on it, and the wrapper allows it to be distributed via the stock exchange instead of, let's say, a normal transaction with a mutual fund where you would come direct to Vanguard.

Liz Tammaro: And even thinking about that, we can talk about maybe what are some of the benefits of the mutual fund versus an ETF or, sorry, even vice versa, ETF versus mutual fund. And even maybe what are some of the disadvantages.

Jim Rowley: I'll take that because I think I don't necessarily like the word disadvantage. I think differences is maybe the more appropriate term. And we just addressed some of the similarities between ETFs and mutual funds, so it's maybe more important to know what are the actual differences. And really the differences come down to two major items and they both relate to how investors transact in shares of those funds, right? We're talking about exchange-traded funds.

ETF investors, they trade with each other on an exchange in terms of buying or selling their securities, and the price that they get is a tradeable market price. Mutual fund investors, on the other hand, they are buying and selling their shares directly with the fund and they might do that through some type of intermediary, but it's back and forth with the fund itself and they get an end-of-day NAV.

So we think about all the similarities and, again, sometimes there's a discussion about how different they are but, really, the differences come down to those two items. It's trading on an exchange versus direct with the fund and it's trading at a market price rather than getting the end-of-day NAV.

Doug Yones: Yes, and I think, you know, what's happened recently, we're hearing about ETFs everywhere; they're all over the news and we hear about all these positives for ETFs—low cost, low turnover, highly tax-efficient, style purity. And while that's true of ETFs, it's really true of index funds. And I think there's maybe some confusion around all those benefits that come with index funds that really come down to the fact that most ETFs are index funds.

Jim Rowley: I think we actually have a great way to illustrate that. I think we have a chart that addresses that point that Doug was talking about that ETFs are overwhelming. They just happen to be index funds. And when the chart comes up, a simple way to illustrate this is we look at expense ratios. But instead of breaking them down by ETF versus mutual fund, we break them down by index fund versus nonindex fund separated into ETF and mutual fund. And when you see the expense ratios, you see that given an indexing strategy, whether it's a mutual fund or an ETF, the expense ratios tend to be lower than they are for the nonindex strategies, whether it's an ETF or a mutual fund.

So just to reiterate Doug's point there, it has a lot more to do with whether or not it's an indexing strategy than whether or not it's an ETF or a mutual fund.


All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

For more information about Vanguard funds or Vanguard ETFs, visit vanguard.com, or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, or other important information are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

Advisory services are provided by Vanguard Advisers, Inc. (VAI), a registered investment advisor.

© 2015 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.

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Comparing ETFs to mutual funds

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Comparing ETFs to mutual funds

Liz Tammaro: Right. We actually have a live question. William is asking, "Are ETFs more volatile since they can be traded anytime throughout the day and because derivatives can be written on them?" What are your thoughts here?

Doug Yones: Yes, it's a great question. And I think in the news recently that's mostly what we've talked about, volatility of the markets. And we've seen a lot of information here from Vanguard about trying to do the best we can to ignore that noise. And it can be tough.

But when I think about the ETF pricing, the ETF, again, it's an exchange-traded fund. It's a broad-based mutual fund. How those are being priced intraday all day long on the stock market, is market makers are going to look at all the individual securities that make up that fund. They're going to pull in real-time prices of all those different securities, and they're basically figuring out real-time NAV, net asset value.

With Vanguard, when you're transacting on the mutual fund side, that's at that end-of-day net asset value. So once a day you'll see one price for the fund. And so it's not really a question of is it volatile? What you're really seeing is you're seeing the individual security prices moving all day long as the markets are moving. And so it really just becomes a question, as Jim mentioned, of preference. Do you need the flexibility? Do you want the flexibility to trade intraday to buy that exchange-traded fund midday, or are you comfortable just setting your transaction for end-of-day when the fund transacts at its net asset value price?

Liz Tammaro: And similar to that question, we have another one that's come in from Bruce asking about: "How easy is it to buy and/or sell an ETF versus a mutual fund?"

Jim Rowley: A lot of moving parts in that question because I think the default has always been mutual funds because they've been around longer. So it becomes a lot of a comfort decision in many ways where purchasing a mutual fund is usually done in dollars. You put your orders in in dollar terms. You're happy to hit the enter button on your keyboard because you know at the end of the day your order is going to execute at the end of the day with a 4 p.m. NAV. You might be able to get fractional shares because your order gets rounded up into dollars and the mutual fund takes care of the automatic reinvestment for you.

With an ETF, investors need to be aware of transacting through their brokerage account. And now the dynamic might be a little bit different because you have to put your order in in shares, mutually speaking. There's no fractionals there. When you put your order in shares, you get a corresponding dollar amount rather than put the order in dollars and you get a corresponding share amount.

So, you know, the ease comes with a comfort level that a particular individual might choose or have a preference for doing.

Liz Tammaro: I'm hearing you say the mechanics are a little bit different but it's not that one is really more complicated than the other.

Doug Yones: Yes, I wouldn't say it's one is more complicated but, again, a reflection of if we think about mutual funds, they do tend to have sometimes pretty high minimum investment amounts. And so there are times when investors, let's say, maybe don't have that much to invest in a particular mutual fund. With an ETF, they could buy one share. So it is possible to have a completely diversified portfolio holding with just one purchase.

So, again, there's pieces to it, I think, as Jim mentioned, where you do have to be more cognizant of the trading because you're now placing a trade that's going to the stock market. But at the same time, there might be times where you need that flexibility.


All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

For more information about Vanguard funds or Vanguard ETFs, visit vanguard.com, or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, or other important information are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation. Advisory services are provided by Vanguard Advisers, Inc. (VAI), a registered investment advisor.

© 2015 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.