 Personal Finance PowerPoint Presentation, ETF versus Mutual Fund. Prepare to get financially fit by practicing personal finance. Most of this information comes from Investopedia ETF versus Mutual Fund. What's the difference, which you can find online. Take a look at the references, resources, continue your research from there. This by Christina Majowski updated March 25th, 2022. In prior presentations we've been looking at investment goals, investment strategies, investment tools, keeping the two main categories of investment in mind that being fixed income, typically bonds, and then equities, typically stocks. We're mainly focused on the stock side of things here when we're looking at the ETFs and Mutual Funds. Quick recap of what stock is, corporations separately legal entity breaking out the ownership into units of stock, which represent equal units of ownership of the corporation. The corporation then might be traded on an exchange, publicly traded corporation. The exchange allowing easier access to individuals, benefiting the corporation because they can generate capital or cash by having a wider pool from which to issue stocks to. It benefits the individual who has the capacity then to invest in the stocks that are traded on the exchanges more easily. However, it's still costly to be purchasing individual stocks oftentimes and it's more difficult to diversify the portfolio then if you use other tools such as the ETFs and the Mutual Funds, which both are a tool that can basically pool investments together under the umbrella of say an ETF or a Mutual Fund, which might be specific to a particular type of goal of the particular fund, allowing individual investors to be able to invest less money, but still grab some diversification and get the benefits of diversification. So most people that are individual investors that are looking for a long term horizon for their investment and possibly using tools such as a 401k plan, 403b plan, or an IRA are utilizing some component of an ETF or Mutual Fund as part of their strategy. So what's the difference then between the ETFs and the Mutual Funds? Let's look at it now. Investors face a bewildering array of choices, stocks or bonds, domestic or international, different sectors and industries, value or growth, etc. When we start diving into the weeds of investing, it can be quite overwhelming. Part of the benefit of the Mutual Funds is to make things a little bit more simplified, hopefully, while still getting diversification for individual investors, deciding whether to buy a Mutual Fund or exchange traded fund, that's the ETF, may seem like a trivial consideration next to all the others, but there are key differences between the two types of funds that can affect how much money you make and how you make it. Both Mutual Funds and ETFs hold portfolios of stocks and or bonds and occasionally something more exotic such as precious metals or commodities. So they're similar in nature in that you typically have your Mutual Fund or ETF, which is holding onto multiple different kinds of investments, depending on the term of the Mutual Fund managed by the fund manager, individuals investing in it are in essence pooling their money together, that money then being distributed amongst the assets, so you can get that diversification. So they must adhere to the same regulations concerning what they can own, how much can be concentrated in one or few holdings, and how much money they can borrow in relation to the portfolio size and more. Beyond these elements, the paths diverge and that's our concern here. What's the differences between the two? So some of the differences may seem obscure, but they can make one type of fund or the other a better fit for your needs. Now remember that the Mutual Funds have been around a bit longer, and so now we've got the ETF, so it can be a little bit confusing between the two. We're going to start then with the Exchange Traded Funds. This is the newer of the two. So as the name suggests, Exchange Traded Funds trade on exchanges. So the funds themselves change trade on the exchanges just as common stocks do. So in other words, when you buy and sell common stocks, typically you're buying and selling them on the exchange. You're normally not buying them from the issuer of the stock unless it was an initial public offering, but often times from other kinds of investors. The exchange, if you have an ETF, it has a holding then of stocks within it or investments within it or under the umbrella of it and are being traded under the umbrella by the manager of the ETF. But then you can buy and sell the ETF itself on the exchange. So at the other side of the trade is some other investor like you, not the fund manager. So when you're buying and selling the ETF, you're buying and selling the ETF kind of similar to buying and selling the stock, except that the ETF is an ETF representing the holding or the holding or the umbrella of the holdings rather than a single stock. So you can buy and sell at any point during the trading session at whatever price is at the moment based on market conditions. So that's kind of nice because then you can trade the ETF in a similar way as the stocks. And if you're trading ETFs like stocks, meaning you're not holding them on to them for a long period of time possibly, but you're kind of trading them, then you can trade them during the day, not just at the end of the day. In that case, again, a lot of people might not be doing that because you might be holding the ETFs for more of a long term or extended time, but you have that capacity. And there's no minimum holding period. This is especially relevant in the case of ETFs tracking international assets where the price of assets hasn't yet updated to reflect the new information, but the U.S. market valuation of it has as a result, ETFs can reflect the new market reality faster than mutual funds. Again, that might not be a big difference to people that are holding ETFs for a long period of time, have a long time horizon, but that updating can be beneficial depending on how often, you know, or how you're using the ETF. Another key difference is that most ETFs are index tracking, meaning that they try to match the returns and price movements of an index such as an S&P 500 by assembling a portfolio that matches the index constituents as closely as possible. Now, when you're investing under these umbrellas like an ETF or mutual fund, then you've got the fund manager to some degree that's going to be helping to buy and sell what's under the fund. The question then is how restricted is that fund manager? You could put restrictions on the type of stocks and bonds or investments that they're going to have, and you can also say, I'm going to really restrict them by saying, I want you to tie your information to the indexes, indexes being kind of like an average of the performance. So you can kind of think of it as though we're trying to like take a survey of how people are going to vote. We're going to take a pool of people that are going to possibly represent the whole population and extrapolate that result to the full population. That's what the basic indexes are kind of doing. That's how the market is measured by these averages. So we could say, hey, look, I want you to have the ETF tied to the index, which means I don't want you actively managing really or having too much control over what you're going to do. I just want you to manage our portfolio to tie into the index, meaning we're betting on whatever the average of the index is. Now mutual funds can do this too, but you can also buy mutual funds that are not tied to an index. And so they're going to have more active management involved. So it depends on what you're what you want in that case. So passive management isn't the only reason ETFs are typically cheaper. So if you have passive management instead of an active management, then you would think the index would be cheaper because the passive manager is not picking and choosing the stocks under the portfolio. They're just tying it to the index. So index tracking ETFs have lower expenses than index tracking mutual funds. So now you can say, well, there are index tracking mutual funds, why now we still have the ETFs with lower expenses and the in the actively managed ETFs out there cheaper than actively managed mutual funds. So it seems cheaper on the ETF. So clearly something else is going on. It relates to the mech mechanics of running the two kinds of funds and the relationships between funds and their shareholders. So with an ETF, because buyers and sellers are doing business with one another, managers have less to do. So with the ETF, you're kind of taking the middleman out to some degree. If you can take the middleman out and still get things done, then you would think there would be less cost, less expenses, which could be beneficial, of course, to the investors. The ETF providers, however, want the price of the ETF set by trades within the date to align as closely as possible to the net asset valuation of the index. So to do this, they adjust the supply of shares by creating new shares or redeeming old shares. Price too high, ETF providers will create more supply to bring it back down. All of this can be executed with a computer program untouched by human beings. So the program is tying it to the index to tie all this out, which means that it should be somewhat automated and you shouldn't have that human involvement and therefore the price should be cheaper for it. So the ETF structure results in more tax efficiency too. Investors in ETFs and mutual funds are taxed each year based on the gains and losses incurred within the portfolio. Now note, oftentimes people have holdings in an ETF or a mutual fund that's under an umbrella of a tax deferred plan, such as a 401k or an IRA plan. If that's the case, then you may not be taxed until you pull the money out of the 401k or an IRA plan. However, if you're not under the umbrella of a 401k or an IRA plan, normally if it was just stocks, for example, you're buying and selling stocks, if you hold on to the stocks, then you're not getting charged gains as you hold on to the stocks because even though the stock has gone up in value or hopefully it has, if you haven't sold it, you haven't realized it and therefore it's not an taxable event. However, when you sell the stock, you could be subject to taxes. If you have something under the umbrella, like an ETF or a mutual fund, then you haven't sold the ETF or a mutual fund, but there's still activity going on within the ETF or mutual fund, the buying and selling of stocks, which could result in taxable events that you would get 1099s on at the end of the year, so on. But ETFs engage in less internal trading, so they do less trading and less trading creates fewer taxable events. The creation of a redemption mechanism of an ETF reduces the need for selling. So unless you invest through a 401k or other tax favored vehicle, your mutual funds will distribute taxable gains to you, even if you simply hold the shares, meanwhile, with all ETF portfolio, the tax will generally be issued only if and when you sell the shares. So ETFs are still relatively new, while mutual funds have been around for ages. And you could think about that particular situation as mutual funds being a little bit more proven than ETFs at this point in time, so you've got some nice things about the ETFs, of course, but again, they're not having been around quite as long, which to me gives the mutual funds a little bit of an edge in that particular area thus far as well. But in any case, so investors who aren't just starting out are likely to hold mutual funds with built-in taxable gains. So in other words, if you're saying, hey, look, there's some benefits here, possibly ETFs being cheaper to some degree for managing the ETF, meaning if I want to put money into a mutual fund or an ETF and I just want to have an indexed fund, then the mutual fund we're hearing here at might be more expensive than putting my money in a related ETF. However, taking money out of a mutual fund and then investing in the ETF could trigger a taxable event. So you've got to be careful about that because again, if you're holding on to something and you haven't sold it, then you might not have a taxable event. But if you sell something in order to invest in something else, that might result in a taxable event. So if you're thinking, hey, I should move over from my mutual fund to an ETF, you've got to be careful about how you're going to move that position will trigger taxes and then take that into consideration. So selling those funds may trigger capital gains taxes. So it's important to include the tax cost in the decision to move to an ETF. The decision boils down to comparing the long term benefit of switching to a better investment and paying more upfront versus staying put in a portfolio of less optimal investments with higher expenses. Now let's take a look at mutual funds. When you put money into a mutual fund, the transaction is with the company that manages it like the vanguards, the T-Raw prices, the black rocks of the world, either directly or through a brokerage firm. The purchase of a mutual fund is executed at the net asset value of the fund based on its price when the market closes that day or the next if you place your order after the close of the markets. So notice we've got to make the purchase at the end of the day because of the way the mutual fund is structured as opposed to with the TETFs, which you can make the trades basically throughout the day. That might not be a big detriment to many investors who are often putting money into either the mutual fund or the ETF possibly for a long term period, possibly looking to hold onto it for a long time frame. If you're looking to purchase and sell ETFs on a shorter basis or mutual funds in a similar way as you might with the stocks looking for more of the short term gains, then you would think that would be more of a detriment. So when you sell your shares, the same process occurs but in reverse. However, don't be in too great of a hurry. Some mutual funds assess a penalty, sometimes one percent of the shares value for selling early, typically sooner than 90 days after you bought in. So when you put money into the mutual fund, the mutual fund isn't really designed for people to be on the short term putting money into the mutual fund and then selling it on a short term time horizon because again, most people when you put money into the mutual fund, you're doing so on the long term time horizon. So there might be some restraints saying if you're going to invest in the mutual fund, we want you to be in the investment for at least the 90 days or you could have a penalty related to it. Mutual funds, again, I don't think that would be a big problem if your goal is to be investing on the long term time horizon. But if you need the money sooner or if you're trading the mutual fund in a similar way as with the stocks, that could of course be more of a pop problem. Mutual funds can track indexes, but most are actively managed. So note that the actively managed mutual funds would mean now you're putting money pulling it together into a mutual fund and you're giving the manager more active control. You can give various different types of management control. You might say, hey, I want you to be investing in a particular sector, but within that sector, I'm going to let your expertise roll within that sector or you might have more of like a targeted fund where you actually want the fund to change over time and have the mix of the fund change or something like that. But you can do, as is the case with a lot of the ETFs, have them tied to an index. So you could do the same thing with a mutual fund. You could say, I want you to be tied to the indexes so that the manager now has very little control. You would think that that would lower the costs of the managing of the mutual fund because the mutual fund is there then now just to tie the mutual fund investments to the indexes. So in that case, the people who run them pick a variety of holdings to try to beat the index that they judge their performance against. So if you have active management, the whole goal of the active management is that if you're managing within a particular sector, you're hoping the manager outperforms the market. That's what their expertise is there to do. Can they actually do that in the long run? Again, it's hard to tell because you can't really tell someone's performance until after they're dead basically, after their career is over, because someone's performance over a short period of time, even 10 years, is not really reflective of what their performance will look like. It might just look like their risk tolerance level happened to match what would be best for the environment for that short time period. It doesn't really see how they will perform in different environments, how they can adapt. So this can get pricey as actually managed funds must spend money on analysts, economic and industry research, company visits, and so on. So notice that an active managed portfolio not only has to beat the market, they have to beat it by enough of a margin that they pay for their own services, which can be costly. Although when you're talking about a big pool of money, you've got a big pool of money that is going to be paying for those services instead of just used. So that typically makes mutual funds more expensive to run and for investors to own than ETS. So mutual funds and ETS are both open-ended, that means that the number of outstanding shares can be adjusted up or down in response to supply and demand when more money comes into and then goes out of a mutual fund on a given day, the managers have to elevate the imbalance by putting the extra money to work in the markets. If there's a net outflow, they have to sell some holdings if there's insufficient spare cash in the portfolio. So what's the bottom line? Given the distinctions between the two kinds of funds, which one is better for you? It depends. Each can fill certain needs. Mutual funds often make sense for investing in obscure niches, including stocks and smaller foreign companies and complex yet potentially rewarding areas like market natural, neutral or long short equity funds and the future esoteric risk reward profiles. So but in most situations and for most investors who want to keep things simple, ETS with their combination of low costs ease of access and emphasis on index tracking may hold the edge. So their ability to provide exposure to various market segments in a straightforward way makes them useful tools if your priority is to accumulate long term wealth with a balanced broadly diversified portfolio.