If you’re looking to save money for a short, intermediate or long-term goal, such as retirement, you need to find a safe place to park it, earn interest, and have fairly access to your money.
But, how do you find such a safe place?
The good news is that there are several places to put your hard-earned savings.
Besides a savings account, three of the most common accounts available to you are mutual funds, index funds and certificate of deposits.
We will discuss the advantages and disadvantages of these short and long-term investments below.
Before we go in detail with the differences between these accounts, you might be wondering about mutual fund.
You may have heard a lot about certificate of deposits, but you may not know a lot about mutual funds.
But one thing you should know is that the question of ‘what is a mutual fund?’ is searched online more than 16,000 each month.
So people are actively looking for the definition. This is what a mutual fund is:
What is a mutual fund?
A mutual fund is an investment vehicle, where investors pool their money together to buy shares.
A professional manager manages the fund. They invest the money for you in securities such as stocks and bonds.
However, a mutual fund differs from an index fund, a certificate of deposit, or Vanguard CDs.
CDs are safer than mutual funds and index funds, because mutual funds and index funds invest in stocks and bonds. One type of mutual fund, money market fund, invests in money and is quite safe.
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Nonetheless, mutual funds and index funds in general are safe for various reasons (more on this below).
One thing for sure is that in most cases, you can expect a higher return on your investment with a mutual fund and index fund than a certificate of deposit.
However, be ready to come up with a bigger minimum deposit with a mutual fund and index fund.
Mutual funds vs index funds vs certificate of deposits: what’s the difference?
All of these accounts are safe comparing to investing in individual stocks. However, there are key differences between mutual funds, index funds and certificate of deposits.
First of all, most mutual funds and index funds invest in stocks or bonds — with the exception of money market funds, which invest in “money.”
Even though there is a possibility that shares in a mutual fund and index fund can drop significantly due to volatility of the stock market, mutual funds and index funds return a much higher yield than a certificate of deposit.
However, index funds deliver a better return than mutual funds.
Index funds, unlike mutual funds, are managed by a computer. An index fund simply invests to match the performance of an index such as the Standard & Poor’s 500 index of 500 large U.S. company stocks.
So, they stay invested and thus deliver better returns.
Unlike certificate of deposits, mutual funds and index funds do not require you to keep money for a specific period of time.
With a mutual fund, just like an index fund, you are free to withdraw your money at anytime you want. In other words, there is no penalty for selling your share in a mutual funds.
However, CDs have something that mutual funds and index funds lack. They are insured by the federal government (FDIC insurance) for up to $250,000. That means your money is always protected.
Having said, mutual funds that invests in stocks or bonds are still safe due to their diversification.
Mutual funds are safe, because they invest in dozens of stocks (from large, mid, and small size companies) across different and multiple industries.
Advantages and disadvantages of mutual funds vs index funds vs CDs
To understand better how these products can grow your money, it’s important to know their pros and cons. Here they are:
Generally, mutual funds offer higher returns than certificate of deposit.
- Higher returns: Compared with CDs and savings account, expect a a higher return on your money.
- Accessibility: You can easily sell your shares, either via your fund company’s website online or via their toll-free number. Also, most money market funds offer check-writing privileges.
- Diversification: while most mutual funds can be risky (especially those that invest in stocks), their diversification make them a safer investment. Most mutual funds own stocks or bonds from dozens of companies across multiple industries. So, if one stock is not doing well, another stock can balance it out.
- Less safe: Unlike CDs which are FDIC insured, mutual funds are not. If you want to make sure that you don’t lose your money because you want it in the short term, stick with money market funds. Although, they too are not federally insured, they are considered very safe.
- Initial investment minimum: Most mutual funds have high minimum investment requirements compared with saving accounts and certificate of deposits. Many mutual funds have minimums of $3,000 or more.
Index funds, unlike mutual funds, are passive. That means they are managed by a computer and not actively managed by a fund manager.
Index funds seek to track the performance of a particular index, such as the Standard & Poorâs 500 index of 500 large U.S. company stocks or the CRSP US Small Cap Index.
Index funds donât jump around; they stayed invested in the market.
Easy to purchase: Just like mutual funds, you can buy index funds through fund companies like Vanguard and Fidelity.
Expense is low: Like mutual funds, index funds have low-cost, which is usually less than 1% annually. This lower operating expenses help boost your returns.
Diversification: Another benefit of index funds is that they are diversified. Like mutual funds, they invest in multiple companies, thus spreading out the risk.
Tax-friendlier: When you invest in index funds in non-retirement accounts, you are taxed less than you would in mutual funds.
Because mutual fund managers are actively buying and selling in an attempt to increase returns, that increase a fund’s taxable capital gains distributions. Index funds are traded less frequently.
One of the downside with index funds, is that they wonât outperform the market they track.
Certificate of Deposit
If you need safety and a competitive yield on your money, CD is a good place for you. But you will need to agree to leave a certain amount of money with a bank for a specific period of time.
If you withdraw your money before the agreed period of time, you will end up paying a penalty.
Depending on the length of the CD and the amount of money you put in, you might earn a higher return than a regular savings account, but not a mutual fund.
- Safety: CDs like savings accounts are federally insured up to $250,000. That means your money is protected.
- Interest rate: CDs pay a higher interest rate than savings account.
- No fees: Unless you don’t withdraw your money before maturity, there is no fee.
Low accessibility: When you invest in a CD, the money is not easily accessible. You can withdraw the money, but a penalty will apply.
Penalty: if you withdraw your money before it becomes “due” or before it “matures,” then you will pay a penalty.
However, there are some banks that offer CDs with no penalty. But these CDs usually come with lower APYs.
Who should benefits from mutual funds, index funds and CDs?
Choosing among a mutual fund, index fund, and CDs depend on your goals (whether short-term and long term) and your current financial situation.
If you don’t have a lot of money, it might make sense to start with a CD, since some CDs have minimum deposit requirement as low as $1000 or less.
A CD investment can be used as short-term investment as well.
If you’re thinking of buying a house in 2 years and want the money for the down payment, a CD is a good choice.
But if you’re thinking of tapping into your money at any time, then a savings account can be a better option.
On the other hand, if you want to save for retirement, mutual funds and index funds are good long-term investments.
These investment vehicles are the most aggressive because they invest in stocks and bonds. More specifically, they are good for you if:
- don’t expect to tap your money for 5 years or more;
- you want to maximize your income and are willing to tolerate the stock market volatility.
How to use mutual funds, index funds, and CDs for your saving goals
These accounts can help you save money for different type of goals.
If you invest money for long-term goals, such as retirement, index funds and mutual funds are great choices.
So, don’t use these funds to invest money you plan to use in the next 5 years or so, because the stock market can drop significantly and you can lose your money.
For short-term goals, consider CDs. As mentioned, CDs are a safe, higher-yielding alternative to savings accounts.
Best Index Funds
So what are the best index funds?
No doubt, Vanguard has some of the best index funds. Among them is the Vanguard S&P 500 Index Admiral (VFIAX).
This fund invest in 500 of largest U.S. companies with a few a midsize stocks. Some of the big companies in this index fund includes Apple (AAPL), Microsoft (MSFT), and Google/Alphabet (GOOGL).
Moreover, this Vanguard index fund has a pretty low cost, (0.04%) if not the lowest of all the index funds.
Plus, the initial minimum investment is also low ($3,000).
So if youâre looking for an index fund that maintains low operating expenses while enjoying a good rate of return, the Vanguard S&P 500 Index Admiral is for you.
Best Mutual Funds
We are big fan of Vanguard Mutual funds. The reason is simply because they are of high quality, reasonably cheap, professionally managed and are cost-efficient.
So, if you’re in the market for the best Vanguard funds, you have many options to choose from. One is the Vanguard Total Stock Market Admiral (VTSAX).
This Vanguard fund gives long term investors a broad exposure to the entire US equity market, including large, mid, and small cap growth stocks.
Some of the largest stocks include Apple, Facebook, Johnson And Johnson, Alphabet, Berkshire Hathaway, etc…
Note this Vanguard fund invests exclusively in stock. So itâs the most aggressive Vanguard fund around. You need a minimum of $3000 to invest in this fund. The expenses are 0.04%, which is extremely low.
Vanguard CDs are the best out there. But you should know that Vanguard only offers brokered CDs.
Banks issue brokered CDs. Banks sell them in bulk to brokerage firms such as Vanguard and Fidelity.
Vanguard CDs are some of the best, because they offer higher rates than most Bank CDs.
In conclusion, there are several options to choose from when it comes to finding a safe place to save and invest your hard-earned money.
Speak with the Right Financial Advisor
- If you have questions beyond investing in index funds, mutual funds and CDs, you can talk to a financial advisor who can review your finances and help you reach your goals (whether it is making more money, paying off debt, investing, buying a house, planning for retirement, saving, etc).
- Find one who meets your needs with SmartAssetâs free financial advisor matching service. You answer a few questions and they match you with up to three financial advisors in your area. So, if you want help developing a plan to reach your financial goals, get started now.
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The post Grow Your Money: Mutual Funds, Index Funds, & CDs appeared first on GrowthRapidly.