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
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 2021, you owe $3,000 of taxes.
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 2021
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:They've been around a long time since 1924, and they're certainly regulated by
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 1993 with the S and P 500 was the first one.
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:.
