In this episode, Matt and Mike discuss all the nitty-gritty details of Exchange Traded Funds (ETFs) and Mutual Funds. What are these funds? How are they similar? How are they different? But most importantly: Which should you choose?

Tune in as we discuss:

  • Why some investors were hit with a big tax bill for holding a mutual fund!
  • Why you should invest in ETFs in your brokerage accounts.
  • What are A, B, and C class shares of mutual funds?
  • What is an index fund?
  • The difference between an active and passive fund.
  • Why are mutual funds and ETFs taxed differently?
  • Can you exchange a mutual fund for an equivalent ETF?

Find out more about Mike at https://www.mortonfinancialadvice.com and connect at https://www.linkedin.com/in/mwsmorton/

Transcript
Matt:

Welcome to real financial real financial on WK Excel available wherever

Matt:

you get your podcasts I'm podcasts I'm Matt always by Mike Morton of advice

Matt:

and the host advice and the host of financial planning for entrepreneurs

Matt:

and outstanding new cover art of art of Mike Borton sitting on staircase.

Matt:

The lighting is The lighting is such that it looks like the a theorial light of down

Matt:

shining down as you ascend life's ladder towards some towards some novels financial

Matt:

novel really a It's really a perfect theme

Mike:

And did just say that whole spiel on one breath?

Mike:

I think you just took one

Matt:

did one I did one breath and that's, this is how my stream

Matt:

of consciousness works It sounds like I just was cramming for the English portion

Matt:

of my I don't know I don't know why my brain just does It just does You're does.

Matt:

You're also listening to this probably in the Capitol podcast feed The reason

Matt:

The reason I'm pushing the podcast versions is that today's show Obviously

Matt:

a lot of Obviously, a lot of folks are XL radio which XL radio which we

Matt:

appreciate today's but today's show Mike were to be a little bit more going to

Matt:

be a little bit more of a deep dive.

Matt:

So we want people to check out the podcast you might have one of might

Matt:

have one of to hit that 15 second 15 second rewind something again.

Matt:

you're not going You're not You're not going to spare the

Mike:

No, this is going to be sort of a master class on versus mutual funds.

Mike:

And I wanted to get into a little bit of the nitty gritty

Mike:

between the two so everyone can understand exactly the differences.

Mike:

So there might be, know might a little bit long in terms of the podcast getting

Mike:

a little bit longer, and there'll be an associated article with this.

Mike:

well.

Mike:

So for those, just really trying to understand the nuances, we're

Mike:

going to dive into that today.

Matt:

Fantastic.

Matt:

And that's another that's another on you're listening on radio, check out

Matt:

the capital closeup podcast feed or financial planning for entrepreneurs,

Matt:

because there's probably going to be more content than we're able

Matt:

to get into this on the radio.

Matt:

Okay Enough Okay.

Matt:

Enough filibustering ETFs versus mutual funds What's an funds.

Matt:

What's

Matt:

an ETF

Mike:

ETF exchange traded fund.

Matt:

you already Yeah you already lost me there is it

Matt:

really it Is it really different

Matt:

than a

Mike:

no they're exactly the same.

Mike:

So

Matt:

All right.

Matt:

Well that's All right Well that's been financial planning for entrepreneurs.

Matt:

Thank you for today's show.

Matt:

We know there are differences.

Matt:

There are

Mike:

are differences.

Mike:

Bottom line upfront.

Mike:

All right.

Mike:

So bottom line up front for this episode is ETFs and mutual funds very simple.

Mike:

In many ways.

Mike:

Okay.

Mike:

But hold ETFs exchange traded funds.

Mike:

It'll usually have the name in the T in the name of it will say ETF,

Mike:

hold ETFs in your taxable accounts,

Mike:

Your brokerage account, make sure you have ETFs in those accounts and not.

Mike:

Mutual funds.

Mike:

Now there might be nuances to that, that's just the bottom line upfront

Mike:

is they're more tax efficient.

Mike:

say you will save more money.

Mike:

There'll be more money in your pocket.

Mike:

If you use ETFs in your brokerage account, rather than mutual funds,

Matt:

Got it.

Matt:

Okay.

Matt:

So ETFs in your brokerage got any other account any other types of accounts

Matt:

where you should have ETFs and maybe you can also give maybe you can also

Matt:

give some examples of the types of where you'd prefer to have mutual funds

Mike:

Yeah that's the big one is just because the tax situation.

Mike:

That's one of the reasons ETS were created.

Mike:

There's other we're going to dive into otherwise I'm not too concerned

Mike:

about it in tax free or tax deferred.

Mike:

These are your 401k is for BS.

Mike:

IRA You could hold either one you're not paying taxes throughout the year on any

Mike:

growth or dividends or capital gains.

Matt:

me ask you So let that's actually super clear super clear definition,

Matt:

the bottom line up the bottom line up front is good is this important?

Matt:

why is mean Why is this worth deep dive

Mike:

Yeah So let me tell a story that came out towards the end of

Mike:

last year about Vanguard We have talked a lot about target date funds.

Mike:

Okay.

Mike:

Target date funds Are those retirement?

Mike:

funds And they hold a mix of stocks and bonds in there.

Mike:

And often these could be a mutual fund or an ETF in this case, the store.

Mike:

It's about an ETF target date fund, and Vanguard lowered the amount

Mike:

that you had to invest in one of their low-cost target date All From

Mike:

a hundred million down to 5 million.

Mike:

Now these are big numbers.

Mike:

You have to invest a minimum of a hundred million.

Mike:

Who's investing in that the pension funds and stuff When it

Mike:

got lowered to 5 million, everybody rushed into that lower cost.

Mike:

Okay.

Mike:

So have a target date fund that all these institutions now with, multi-millions

Mike:

could now get into a lower cost.

Mike:

Of course, they're going to take advantage that Move out of the one

Mike:

fund with the higher cost into one, with the lower cost, because of

Mike:

all the money, leaving the people.

Mike:

This isn't a, sorry, this is a mutual fund, not an ETF mutual fund.

Mike:

Okay.

Mike:

So of all the people leave.

Mike:

Everybody who is left holding that target date fund mutual fund in their brokerage

Mike:

account got hit with capital gains.

Mike:

Now I'll spare you the details of why this works.

Mike:

We might get it in the episode, but the point is, if you have a mutual fund, if

Mike:

you had this mutual fund in your brokerage account at the end of last year, if had

Mike:

bought it, say a hundred thousand dollars, this target date fund mutual fund.

Mike:

At the end that, you just invested a hundred thousand dollars mat

Mike:

into this target date fund.

Mike:

you're going to hold it for 20 years.

Mike:

had to pay $3,000 of taxes.

Mike:

Why is that?

Mike:

You just invested a hundred thousand dollars.

Mike:

And at the of the year, you got a statement that says, Hey,

Mike:

you the IRS, your tax forms.

Mike:When you filed for:Matt:

Mike, you're making me Mike you're making me nervous someone someone

Matt:

whose name is I don't call him Matt.

Matt:

No no no no That R no no no no That that's uh M Robeson may or may or may not

Matt:

have target date funds with Vanguard M

Mike:

Uh yeah You know

Mike:

Don't worry about it too much

Mike:

bad.

Mike:

No, okay.

Mike:

because you don't have hundreds of thousands of dollars in there.

Mike:

Your 50 bucks you got in it's not going to be big deal.

Matt:

I'm still not looking I'm looking forward to the tax

Matt:bill I'm I'm working on my:Mike:

But yeah, let me just say that again.

Mike:

Cause the reason this was a mutual fund in your taxable brokerage account.

Mike:

And just because you made an investment, the people that hold that investment

Mike:

can get hit with tax consequences based nothing That you really did.

Mike:

It's what other people are doing.

Mike:

All these pension funds ran out, bought something else instead.

Mike:

And so therefore Vanguard had to pass on capital gains people that held that fund.

Mike:

And so you got hit with a capital gains tax, even though all you did

Mike:

was just buy into an investment.

Mike:

You just holding it.

Matt:

is indeed Indeed and I see why we see why we warned be ready to

Matt:

just hit that rewind But I also but I also see what the upshot is here

Matt:

circling just circling back to the top.

Matt:

So what you're saying is.

Matt:

if I had had been in ETFs rather rather than mutual fund in my taxable brokerage

Matt:

account, I would would not have had that

Mike:

100% You got it.

Mike:

So hold ETFs in your brokerage account.

Mike:

All right.

Mike:

That's why we that.

Matt:

Got it.

Matt:

Got it.

Matt:

All right.

Matt:

All right.

Matt:

Go.

Matt:

All

Mike:

So I was just gonna say, let's go ahead and start talking about mutual

Mike:

funds and ETFs and talk about some of the details and then differences.

Matt:

right right right right You want to start Which want to start

Matt:

Which one do

Mike:

yeah, we'll start with mutual funds.

Mike:

Cause they've been around longer.

Mike:

These are an easy way of course, to hold a basket of assets stocks, right?

Mike:

the S and P 500, you want to hold All companies.

Mike:

You buy one mutual.

Mike:

And hold that entire thing.

Mike:

So it's great.

Mike:

It's an it's an easy way of purchasing entire thing.

Mike:

know funds.

Mike:been around a long time since:Mike:

the U S all kinds of regulations about how you a a mutual fund, how you to run the

Mike:

mutual fund, all those kinds of things.

Mike:

They typically have a minimum investment a a mutual fund.

Mike:

So maybe $250, $3,000.

Mike:

I told you this other one was an institutional fond.

Mike:

It was, a hundred million dollars was the minimum investment.

Mike:

So they have a minimum investments and mutual funds settle at the end of the

Mike:

day, based on what you want to invest.

Mike:

So if you want invest that thousand dollars, you go ahead and click

Mike:

the button throughout the day.

Mike:

I want to put thousand of cash in this mutual fund.

Mike:

You actually will end up owning that mutual fund at the end of the day.

Mike:

So you don't get it like right away when you click the button,

Mike:

they settle one time per day.

Mike:

All those buys and sells align at the end of the day.

Mike:

So those are mutual funds.

Matt:

okay.

Matt:

All right.

Matt:

Then about what about

Matt:

ETFs

Mike:

Yeah.

Mike:

So let me stick on mutual

Mike:

funds

Matt:

All right.

Matt:

All right.

Mike:

more

Matt:

All right.

Matt:

All

Mike:

Yeah And we'll to the ETFs.

Mike:

I want to say just a of other things about.

Mike:

Mutual funds, but that's the high level.

Mike:

There's a other there's open-ended funds close ended funds.

Mike:

So you see this open-ended funds are what you typically buy and sell.

Mike:

no limits on the number of shares.

Mike:

So was more people want to buy them the mutual fund company issue more shares.

Mike:

So they're open-ended.

Mike:

if Matt wants to buy a thousand dollars of a mutual fund and no one's around to sell,

Mike:

he can still get his money in there.

Mike:

They'll just issue more shares close in.

Mike:

There's only a certain number of shares, so so you've got to line

Mike:

up buyers and and sellers, so they work little bit differently.

Mike:

Most of the ones out there that you're going to be investing

Mike:

in are open-ended shares.

Mike:

You can just buy them now there's different share classes,

Mike:

and this is really important.

Mike:

And unfortunately, you know advisors often push certain share

Mike:

classes it's better for them.

Mike:

Not necessarily the best for the client because it gets tricky,

Mike:

which share class is best for you.

Mike:

I'll talk about of them.

Mike:

There's a, B and C classes of mutual funds share classes.

Mike:

And what you're doing is you're paying for owning that fund So

Mike:

on the manager of a a mutual.

Mike:

I'm going to have to some buying and selling.

Mike:

I'm 40 hours a week, doing stuff.

Mike:

So I get paid by the investors.

Mike:

In my fund, Matt puts a dollars into my fund.

Mike:

I'm going to take a few pennies of that to pay myself, my salary.

Mike:

Okay.

Mike:

So are we going to do that There's different ways I could do it.

Mike:

I could say Matt at cool, out of your 10,000 bucks take 500 upfront

Mike:

and then really I won't charge you.

Mike:

I'll just charge you pennies from there So I'll take a lot up front,

Mike:

I have more work to do upfront.

Mike:

Yeah.

Mike:

That's called a shares.

Mike:

Front-loaded shares your $10,000 investment.

Mike:

You only actually get 9,500.

Mike:

I took $500 to pay myself

Matt:

right off the

Matt:

top

Matt:

right

Mike:

right off

Mike:

the top.

Mike:

So your investment is 9,500 bucks.

Mike:

And then from there you're hardly paying anything.

Mike:

Okay.

Mike:

Second is B shares their back end loaded.

Mike:

Okay, so you get your $10,000 investment, but if you ever sell Matt, I'm taking 500.

Mike:

I want your money to stay in my fund.

Mike:

So if sell, when you go ahead and sell down the road, I'm going to 500 Now,

Mike:

if you stay in for five years seven years or 10 years, it might go to zero.

Mike:

Okay.

Mike:

So that backend load drops down over Those are B shares, how you pay for them.

Mike:

And finally, there are C shares where you pay a level load.

Mike:

All right.

Mike:

I'm just going to take 50 bucks a year from you, Matt, for your

Mike:

10,000 investment It's going to be 50 bucks a year, no upfront fee.

Mike:

No, no backend fee.

Mike:

Just level load throughout.

Matt:

I I think how do I think about which of those is

Matt:

better

Matt:

for

Mike:

Yeah.

Mike:

If you're going to be invested for the long-term backend

Mike:

loads can be really nice.

Mike:

First.

Mike:

You need to compare what the ongoing maintenance fee for any of those?

Mike:

three?

Mike:

Okay.

Mike:

The C shares are going be a little bit higher than the because the

Mike:

only way I'm getting paid as the manager is level, load every year.

Mike:

Okay.

Mike:

Versus a, I get a big upfront fee or B if redeem them I don't get my every year fee.

Mike:

If you change out after six months, and that's why I charge you way.

Mike:

So you have to compare the load time.

Mike:

And then how long are you going to own the shares?

Mike:

If you're going to own them a long time, the end.

Mike:

load could make sense, because again, it gets stepped down.

Matt:

I see.

Matt:

W so could we make this could we make this kind did for let's say I'm in a let's

Matt:

say I'm in a Vanguard target retirement

Matt:

mutual fund.

Mike:

Yup

Matt:

Would that be Would that be the kind of where I intend to I intend to stay

Matt:

in that fund for 10, years years Backend

Matt:

loaded loaded class

Mike:

of those that you're going to buy yourself are just going to be,

Mike:

C shares.

Mike:

They're going to be level Yeah.

Mike:

That's why I I to that expense ratio 0.1% 0.2%.

Mike:

That's the expense ratio.

Mike:

That's the shares level of.

Mike:

load.

Mike:

That's how they work.

Mike:

The . A and the B are really sold through advisors.

Matt:

I

Mike:

All right.

Mike:

I don't want to get into the details, but if you're working with

Mike:

an advisor and they're saying, Hey, here's a portfolio, we're going set

Mike:

up for I recommend these things.

Mike:

I'll take your a hundred thousand.

Mike:

We'll invest it way.

Mike:

That's where you want to ask the question.

Mike:

Whoa.

Mike:

Okay, what kind of, you what are the investments?

Mike:

How am I paying for them?

Mike:

We just talked about this last episode, right?

Mike:

What the investments?

Mike:

How am I paying for them?

Mike:

How's coming Because I see.

Mike:

this all the time.

Mike:

Oh, you own a shares.

Mike:

spent, two years ago, 10,000 bucks, but you only really Got $9,000 of

Mike:

investment because that was the commission paid to the advisor that took that.

Mike:

That's why they recommended those eight shares.

Matt:

Got it.

Matt:

So the Got it So the bottom I'm basically I'm basically taking I get

Matt:

with with most of that I would that I would buying into, but if I'm setting

Matt:

things up, so I should just be so I should just be in that case in that case

Matt:

with things that with things that I'd be setting up with an that's that's.

Matt:

will have a little you will have a little bit more control and you really should.

Matt:

You really

Matt:

All right

Mike:

these differences Yep There you

Matt:

let's let's let's make sure to I think I I think I got the

Matt:

basics What about What about ETFs

Mike:

very similar.

Mike:

Okay.

Mike:

In terms of you're owning a mix of assets, just the mutual fund.

Mike:

So you can invest $10,000 in the full S and P 500, you get all 500 companies.

Mike:

One ticker symbol, one thing.

Mike:

So they're very similar in that way.

Mike:

ETFs are relatively new they're.

Mike:First came around in:Mike:

It's a new way packaging.

Mike:

Think of it this way.

Mike:

It's a new way of packaging.

Mike:

investment you could do it with mutual funds.

Mike:

Hey, my 10,000 bucks, I own this mix stocks and bonds or whatever.

Mike:

I can do the same thing with ETFs, but it's a different wrapper

Mike:

around a a very similar investment.

Mike:

All right So think of it that way.

Mike:

Now the ETFs purchased and sold on the open market.

Mike:

So throughout the day when you click buy, you're going to own them immediately.

Mike:

All right So you can buy and sell them throughout the day.

Mike:

So that's very different told you mutual funds once a day, they do that match.

Mike:

Okay.

Mike:

But ETFs throughout the day, you can and sell these things Just like you

Mike:

can stocks, you can own a single share.

Mike:

You can own fractional shares.

Mike:

So the fund had that minimum investment, $250.

Mike:

These Nope.

Mike:

You can own a single share fractional shares and trade on the open market.

Mike:

The other differences is.

Mike:

They're based on supply and demand.

Mike:

So even though it's S and P 500, which has, you can look up the, the exact

Mike:

all those 500 companies, how much they each are trading at that moment,

Mike:

the ETF version, maybe slightly above or below though, the 500 components.

Matt:

that does that mean

Matt:

does

Mike:

Now it usually they're not so much.

Mike:

And me just say, before you ask a question, just that's different to that.

Mike:

I didn't say this about the mutual funds, but mutual funds up.

Mike:

At the actual price of the underline, most of the time, the price of the underlying

Matt:

see does that mean that mean then you were kind of watching ETFs even within

Matt:

a single day versus watching mutual ETFs would have ETFs would have more volatility

Mike:

they have more volatility throughout day, for sure.

Mike:

because they trade throughout the day mutual funds.

Mike:

In fact, this is a a good point, when you log in and look at your

Mike:

You know your account, the mutual fund won't change price

Matt:

Oh, I

Mike:

the end the the

Matt:

and your ETFs, you thrilled at thrilled at 9:00 AM a dejected

Mike:

Yeah, In fact, it's funny, you mentioned that because on my app

Mike:

where I'm like watching symbols, I have some mutual funds and they just

Mike:

sit there and yeah Why is this one?

Mike:

Not like going up like

Matt:

the phone It's like update refresh refresh

Mike:

refresh Oh, that's a five o'clock at night.

Mike:

Will it refresh?

Matt:

Got it.

Matt:

And um so you were explaining with mutual funds, are different

Matt:

there, are classes Are there are there different types of ETFs?

Mike:

There are different types ETFs.

Mike:

These aren't so important.

Mike:

It's more kind of the underlying logistics of how one has to work from certain areas,

Mike:

sectors the the market, but they're, open-ended funds there's unit investment

Mike:

trusts And there's grant or trusts.

Mike:

Again, these are different kinds of rappers.

Mike:

They're all under the ETF, but they're to be a little bit different wrappers.

Mike:

That I wouldn't be so about it because there's no real and use difference in

Mike:

terms of the AA shares, B shares C shares.

Mike:

We talked about they can make a difference to you as an individual

Mike:

investor in terms of this.

Mike:

There's nothing that I found so far that it makes any difference

Mike:

but I will come back to that.

Mike:

If at some point I noticed an important difference for

Mike:

consumers around those different

Mike:

types of

Matt:

Got it So it's not like the with mutual funds where you know, if

Matt:

you're setting something up advisor you really do need to be to be aware of

Matt:

the different classes per it's just a

Matt:

different

Matt:

setup

Mike:

that's right Yeah Different Yeah.

Mike:

Different behind the scenes set up for

Mike:

certain

Matt:

Well here's what I want to do We're about to about to get a whole

Matt:

lot lot more on this, difference with index funds et cetera.

Matt:

But for our radio our radio we need to wrap up the show right now.

Matt:

So again check check out close-up or or financial planning for

Matt:

entrepreneurs, if you want much more of this but for the radio the radio

Matt:

listeners, we'll sign off right here.

Matt:

Thanks so much, Mike

Mike:

thanks.

Mike:

Thanks for joining us on financial planning for entrepreneurs.

Mike:

If you like, what you heard, please subscribe to and rate the podcast on

Mike:

Apple iTunes, Google play Spotify, or wherever you get your podcasts.

Mike:

You can connect with me on linkedin or mortonfinancialadvice.com.

Mike:

I'd love to get your feedback.

Mike:

If you have a comment or question, please email me at

Mike:

financialplanningpod@gmail.com.

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