The Pros and Cons of Mutual Funds and ETFs (Which Option is Best?)

mutual funds versus etfs a battle royale it's brian preston the money guy yeah brian i think it's so funny a lot of people look at it that way right they think about mutual funds versus etfs which one's better which ones were should i be doing this should i be doing that and it seemed like that's the common theme out there in the investment world and i'm not so sure that we agree with that i don't know that i think that is this controversial thing between the two it is fun to put things against each other you see it with nightly news you put one talking head that thinks this way another talking head thinks this way let them go at it you know those things happen all the time but we like to think that there's consensus here where you can use both of these as tools in your journey towards financial independence but it is worthwhile the creator the founder of vanguard and the original index fund jack bogle did have some unique things to say about etf so kind of share let's set the table and share what jack thought yeah this is what jack said i think this was around 2007 and she said during the past decade the principles of the traditional index fund have been challenged by a sort of wolf in sheep's clothing the exchange traded fund but let me be clear there is nothing wrong with investing in those indexed etfs that track the broad stock market just so long as you don't trade them so that sounds such a unique statement because when i hear sheeps and whoops wolf's clothing that's like that's a negative thing that's like saying somebody here a wolf in sheep's clothing i was like why is the sheep dressed like a woman with a wolf in sheep's clothing let's get it right because it does have two different things why would it we'll just keep going but it's um it is kind of funny in the fact that you think about that's negative connotation it doesn't mean that you are a wolf that is looking to sneak in take advantage of the situation and that's not what if you really understand how etfs can be an effective tool it doesn't have to work that way but i do think we should pay some respect to what jack was implying is that etfs do have some unique opportunities meaning like they trade intraday and i think just because you can doesn't mean you should and jack is just cautioning you be careful because one of the biggest components of investing in mutual funds is it kind of locks in your behavior you buy and hold think long term and you're rewarded for that so be careful when you add these new fancy snazzy features that they don't distract your behavior and how you handle them so we thought one of the things that might be viable is if we kind of look at mutual funds and etfs what are the pros what are the cons what are the valuable things what are the not so valuable things and how can you use them to ultimately improve your financial life so let's jump right in with mutual funds and in true webster fashion i think one of the things we like to do with the money guy shows whenever there's a financial term we like to clearly define it so what is a mutual fund a mutual fund is an investment fund that allows you to pull your money together with other investors to purchase a collection of stocks bonds or other securities here's something we had fte daniel pull some cool facts i was shocked to find out and this is from the 2019 ici study sure is that still the lion's share of mutual funds are actively managed yeah there's sort of two thoughts there right there's actively managed mutual funds and there's kind of what jack bogle was a proponent of us passively managed index type funds but according to the research that daniel pulled only 29 of all mutual fund assets are in index equity mutual funds so that means the lion's share are still in actively managed funds which was kind of surprising and if you need proof here's some here's some data points on this is that actively manage domestic equity mutual funds experienced a net outflow of 1.4 trillion dollars from 2009 to 2018. so it's changing it sounds like the shot the tides are shifting a little bit about it but but listen to this because that was active manager before we say mutual funds are losing tons of assets because then if you combine index mutual funds and ets more to come on that they received 1.6 trillion in assets so it just shows that there is a shift going on of going from really active management to more passive index type investing but it does show because you notice they combined index mutual funds and etfs so we probably should explain what is an etf yeah so again in true webster's dictionary fashion what is an etf an etf is an investment fund traded on a stock exchange similar to a stock unlike mutual funds though etfs can be bought and sold throughout the course of the day and we'll talk about the behavioral side i do think it's interesting when you look at the trends and what's going on with mutual funds etfs but i think a lot of commission guys a lot of fee based guys not the fee only i think we fee only guys since we get paid directly by clients we've never had a problem with because you know since our clients are paying paying us directly for managing the funds we always have been we've for years like people when i did the index show they're like when did the money guy team become index proponents i'm like guys we've been that way for yx funds for decades so this is nothing new but it isn't the point made by some of the youtube comments is that most financial advisors have been in a quandary when we talk about index funds because you know where index funds typically are there no load meaning there's no commission so if you go to think about some of the biggest you know guys that are in your grocery shop you know in your shopping centers the ones knocking on your doors trying to get you to buy investments i'm not going to say their names but you know who i'm referring to they don't have index funds in their basket of tools etfs has come along and you have seen quite a few fee based type advisors that are using etfs to kind of scratch that edge check the box on buying into index type of products and and here's the proof on this in 2011 10 of of assets under fee based advisors were etfs and by 2017 that number's increased to 28 so from 10 to 28 in the from 2011 to 2017. and then for full service brokers these are your commission guys they had six percent of assets and etfs in 2011 and now that number's increased to 17 at the end of 2017. so it sounds like if i'm hearing you right brian as ets have continued to advance and continue to progress more and more investors of all shapes and sizes brokers individual investors financial advisors a lot of folks are using exchange traded funds more so than they were five ten years ago well i think it just ties into the trend index investing is here to stay passive management is here to stay and we'll be talking about that i did think it was one other data point before we moved to the pros and cons of each of these type of investments etf owners more aggressive in nature here's the research on that 51 of etf owning households are willing to take above average risk or substantial risk only 30 35 percent of mutual fund-owning households are willing to do the same that's also from the 2019 ici um researcher factbook that came out recently when i hear that that kind of makes sense to me because we know you've already alluded this one of the things that's interesting about etfs is you can train trade them throughout the day you can buy them and sell them pretty quickly yeah mutual funds tend to be a little bit slower a little bit more boring you put in your order today and it fills at the end of the day you put your order in to sell it sells at the so it makes sense that someone who wants to be more active more involved do more they would probably tend to lean towards ets as opposed to it's a good way of looking at it i think about that so let's kind of talk about i want to transition and talk about the pros and cons of mutual funds because we are going to find there are some slight differences and things that you can capitalize off of with each of these investment products these vehicles so first let's talk about the pros of mutual funds number one mutual funds can provide a diversified mix of stocks and bonds and are also not as risky as single socks so a lot of folks when they think about investing they think oh i want to go out and buy home depot or apple or google or tesla or fill in the blank of the company you want to buy well you hear us talk all the time and hear other financial folks talk about diversification one of the big things you want to do is spread your assets out across a number of different companies well if you were to try to do that on your own it's a pretty daunting task imagine if you wanted to have s p 500 exposure and you had to go out and buy 500 individual stocks it'd be pretty quickly that'd be a mess mutual funds make it much much easier to do that by buying just one single fund to get that kind of diversified exposure what else do mutual funds do give us some more pros yeah so the other thing that you can do is there is a large variety of funds so it allows you to access different parts of the financial markets you can have international mutual funds large mutual funds small mutual funds hedged equity mutual funds pretty much if you can think of it there's a mutual fund that can satisfy that itch that you need to scratch in your investment portfolio i mean even obscure stuff i mean you see people cannabis is a big thing are there cannabis mutual funds there are mutual funds for anything so that's why it's really kind of interesting to look at these things keep it going uh so the next one is uh you don't need to invest in certain increments with mutual funds so a lot of funds will have it where you can buy 10 20 30 40 50. you can actually buy based on the dollar value you have to buy based on share value which is kind of unique we'll talk in a second about etfs how that's a little bit different mutual funds allow you to buy in customized increments and possibly even on customized timetables so it's probably easier i remember i had my high school moment where my economics teacher said if you guys would invest 100 a month you'll be a millionaire by the time you retire yep it's probably if you say a hundred dollars i want to do a hundred dollars a month mutual funds is probably probably gonna be the way to do it that's very easy because you can buy in those easy increments and that's a perfect segue mutual funds allow for automatic investing so if you're someone who listens to the show and you think man i like this dollar cost averaging thing i want to have my 100 a month go in and buy xyz mutual funds so i can be a millionaire mutual funds are a really easy way to do that because you can just set it and forget it and let it keep rolling and then brian i think the last one this is the one that you talk about all the time mutual funds provide great access to really low cost indexed options oh that's great there's also a lot tax benefits we'll get into that in a minute as well but that's that's a great list of pros let's look at the ugly side of it what's the cons of mutual funds so some do have minimum investments you might need an initial investment of a couple of thousand dollars to be able to access certain types of mutual funds now there's a price war that's been going on between vanguard fidelity and charles schwab i mean you've seen because td ameritrade has merged up into schwab now you've seen some some victims of this battle that's been going on i don't i'm sure the numbers are much different now i do think it's interesting like fidelity they have zero funds meaning they have zero minimums but i do know for years that like if you wanted to buy vanguard there was like a 2500 minimum or things i think those numbers have come way down because there's this price war going on between fidelity and vanguard but in the past that was definitely especially when people called and they said hey i want to open up an investment for my kids i have 500 that threshold i will tell you this con is quickly going away though because now you can open up custodial roth iras you can do all kind of custodial type things minimum to zero fees with like fidelity vanguard there's a lot of good innovation that's going on that's taking away this call yeah it's just you know the the theme you're going to hear over and over is that technology has really changed it's made a lot of the pros of these investment types better and a lot of the cons slowly going away the next con is that generally speaking now not in every single circumstance but generally speaking mutual funds are not as tax efficient as exchange traded funds yeah anybody who started if i want to go ahead and tell you if you weren't paying attention to the money guy show and you invested in a mutual fund in the fourth quarter of 2019 you probably were shocked when you got your 1099 at the end of the year you're like what is this heck is that distribution i got and all this taxable income that this fund because it was not uncommon to have mutual funds that had 15 to 20 of their net asset value meaning being distributed out as income to the shareholders you're probably wow i'm getting a quick education on these things can be tax inefficient i need to be careful uh and then the next one is that mutual funds depending on what fund family or fun company you're buying from they may have trading fees so a lot of funds in order for you to access that fund or that fun family you might have to pay 25 45 75 just to access that fund so there could possibly be some some fees there now even that brine is changing where a lot of funds now offer no load funds or non-transaction fee funds where you can get into without having to pay that but they still do exist well but tell me if i'm wrong on this because i'm a little i don't do the actual trading for clients every day fidelity if you're buying a vanguard fund there is a ticket charge on that that's right that's actually been increasing i would say instead of that going away that's actually i've seen that increase there used to be more ntf fees i feel like but then what's weird is we're about to cover exchange trade funds there's been a price battle to get those down to zero as much as possible so it's just so interesting to see the pros and cons list and the evolution of what's going on behind the scenes with these price wars that's exactly right and then the one thing and we'll talk about this in a second but it's kind of we were trying to figure out does it fit into the pro column or does it fit in the con column and we couldn't decide so we kind of thought it was right in the middle is that mutual funds do trade once a day at the end of the day what they do is they look at the underlying value of all the holdings they determine the net asset value of all the holdings that fund holds and whatever that price is that's what you get to buy or get to sell at so whether you put your order in it 8 30 in the morning or 2 30 in the afternoon you're going to buy or sell the same price as all the other investors if you're a person that wants control that could be a negative thing sure especially because i had a call i had a brand new client we were dollar costs averaging in i think he it was so interesting to me because he finally caught on the third month he was investing with me because he was calling because i was like today's the dollar cost averaging day and he'd call me on those days and be like oh i don't know the market opened up down a half a percent today maybe we should hold off and it was only after the third month that he realized mutual funds traded at the end of the day and i had to explain i was like yeah it doesn't matter what's going on intraday with these so it could be a positive thing but or if you're one of these very controlled people and you want to take advantage of the fluctuation throughout the day it might be a negative for you so it is a kind of in the gray column that's why we had fte daniel put it right in the in between love it okay so let's shift a little bit and talk about pros and cons of etfs or exchange traded funds right the very first one exact same pro as mutual funds same thing is true of etfs you get diversification reduced risk generally if you can spread your assets across a bunch of different companies or holdings or underlying securities you can reduce the overall risk etfs provide a very easy simple way to get that sort of access yep i have nothing to add on that one so you can keep it rolling i love it the next one is they also have a huge variety of funds just like if you want to invest in companies that specialize in hair treatment you can go find your hair treatment etf i made that one up but they can be very very specialized and it's a large variety of funds out there the reason i think it's kind of funny because i feel like i just kind of like yep keep it real these are so similar to mutual funds that these kind of seem like yeah didn't did they accidentally put the same slot up again no it's just that mutual funds and etfs are very similar in some of these benefits so that's why i think it's okay if we keep rocking and rolling through this love it the next one is that generally speaking there are no investment minimums with etfs other than the share price right so generally you have to buy whole shares when you invite buy in etfs so as soon as you have enough to buy one share you should be covered they don't have a hundred dollar thousand dollar 2500 minimum to get into them and just like mutual funds etfs offer you access to very low cost index funds you can go just buy the set it and forget it index same as you can with mutual funds and so just like this was a con for the mutual funds this is actually a pro of etfs generally speaking they tend to be more tax efficient than their mutual fund brethren yeah we'll talk about that in a minute when we get to unique planning opportunities it is one of those things you don't have embedded gains and losses with etfs like you do with mutual funds so that creates a unique planning thing i will tell you it could be good it could be bad but it is nice that they are very tax efficient and you're not buying into the embedded gains of somebody else's portfolio exactly right okay so now let's look at some of the cons so uh here's the first one you can't automatically invest into etfs every month now that is actually also changing too because now some custodians are allowing fractional trading and they will allow you to do that but most custodians still have a hard time if you want to go buy a hundred dollars a month or 500 a month they're probably going to want you to do that in a mutual fund versus in an etf which is not as easy because they have to make the decision for you does it buy at the beginning of the day or the end of the day or the middle of the day because of that they generally won't allow you to do that and some do also have trading fees if you want to buy a mutual fund now again and i feel like we keep giving like disclosures on every single one everything's changing i mean these system when you watch this show in three years from now it could be a little different because this is talking about well i mean because it is it's constantly changing it's just like i will tell you traditionally historically if you're buying monthly you want to be buying a mutual fund because of exactly the the automatically investing in ets with the pricing structure it's weird when it's buying it could have trading fees but bo nailed it these things are evolving and i do worry three to four years from now this could be a different the con could be completely you could co-mingle the ets and mutual funds even more because of what technology is doing to them now the other thing that is a little unique to etfs relative to mutual funds is that um there could be liquidity issues with smaller etfs it depends on the volume of that etf that trades i already know why you're well look and we'll bring it up later but we had a 40-minute sidebar discussion when we were doing pre-show meeting on this is because and ribby but i felt so bad because we're we're all financial nerds here she's the premium versus discount of etf pricing i can see the glaze so we we're just go we'll pause it there just keep going and we'll just keep it going so then okay as you can probably guess there is some middle ground and here's what we think the big middle ground is with the pro and con of etfs is that there is intraday pricing so unlike mutual funds only trade once a day at the end of the day etfs trade just like a stock throughout the course of the day you can buy and sell and buy and sell however it might not always be a good thing yeah we kind of went into went over that on when it's positive or negative it depends on how much control you want and sometimes that ability to trade intraday could actually be your enemy and we'll go over that in a little bit as well as we get unique planning opportunities but let's kind of let's talk about the expenses because i think that is something we all are curious about daniel went and pulled the annual research i pay attention every year to see what the trends are realize when i started managing money in the 90s the average internal expense for a mutual fund was over one and a half percent even today that just sounds insane to think about paying over one and a half percent per year internally on a single fund and then a lot of them had loads on the front end you could buy you know a shares b shares and think about this if you were buying a b or c share it wasn't uncommon for the internal expenses to be pushed up to two percent or really close to two percent or even over there was a lot of b shares because we realized b shares were trying to look like index funds in the fact that there was no or no load funds because they had no commission on the front end but the internal expenses it was not uncommon for the internal expenses to be around two and a half percent and then if you sold them it was a declining it was like five percent the first year four percent in the second year three percent it was a step down process these things were horrific thank goodness innovation just competition has created much better products for the investment landscape there's no better time to invest in right now that's exactly right and so one of the things we wanted to look at is and we get asked this all the time from folks okay well which one is cheaper right you hear you hear both you know low cost and low cost well which one's really the most low cost which one is really the cheapest investment to buy so we had fte daniel go pull together the data points and here's what we found by the way you guys pick on us so much about the use of average we use median so take the median and you can see all funds i do think this is interesting we look at mutual funds like i said the average was over one and a half percent when i started managing money in the 90s now it's 0.88 percent etfs you look at that you go wow half a percent that's even cheaper than the mutual funds but then i think it is kind of interesting when you look at we told you the lion's share of mutual funds is still actively managing you can see there's a lot of people that are paying for managers i would question are they really getting any alpha for that but they're paying close to one percent on the equity they're paying 0.66 on the bonds etfs are substantially cheaper but this is such a unique thing and then you look at the indexed equity funds these are just mutual funds and etfs that are buying into the indices and you can see mutual funds the median is .33 versus etf is it .47 but guys here here's what these numbers don't show you might make this and you look at this and go i'm going to just determine that if i'm buying indexes i ought to just buy mutual funds so according to this chart they're cheaper you need to do more research than that because here's what i mean by is that if you buy if you look at spy okay yeah the s p 500 etf it's it's zero nine percent point zero nine five percent i believe so for every thousand dollars you invest it's like 95 it's 95 cents that that's practically free by the way it's very cheap but then what's the other one that we which you see us use it's also an scp-500 ivv i shares s p 500 that one is .04 something around so it's four cents for every thousand dollars but then i'm gonna blow your mind because you go look at the fidelity s p 500 fun and it's .015 yep so it's 15 cents for every thousand dollars you see these averages up here where it's 0.33 or 0.47 depend upon if you're looking at mutual funds versus etfs but if you just do a little due diligence you can see there are funds that are actually practically free and then fidelity actually has zero zero which have you know which you can do total market funds other things they can't call it a standard and poor's s p 500 because then they have to pay some some fees for that but they have something like large u.s companies which is very similar to the s p 500 which is free so if i'm hearing you say this when it comes to like designing your portfolio and just and picking which investment options which investment types you're going to use it's probably not going to be all etfs or all mutual funds if you're going based solely on expenses because sometimes the etfs are more inexpensive and sometimes the mutual funds are more inexpensive you really kind of need to do your research to understand what fits your portfolio best is that what i'm hearing you say for sure exactly and but that does lead to the next question is you're asking yourself well if it's so much cheaper to do these passive strategies active versus passive when does where does this all come into play with active versus passive and by the way it used to be that active was only on the mutual fund but we started to see this is why these things are so co-mingled you're starting to see etfs that now have some managed component or smart alpha um you know so they have some some weight component where which when you see alpha or smart beta that means a manager's not making some sort of they're not making the indices they're not just buying the indices for what it is they're starting trying to make some determination of why this is good or bad so it's like management is coming into play so we wanted to kind of talk about this so when you talk about active versus passive it is interesting when you look at spiva data i mean it's it's crazy was it like 88 percent of they can't you know the index beats 88 of the managers over uh you know anything greater than five years on the large cap side when you start thinking about that that means eight to nine um of the ten funds are going to underperform the index fund you have to ask yourself what's going on what am i actually getting value from these active managers so give them kind of the abound thoughts on active versus passive bonus yeah so what we love is that where we can index where we can buy super low cost not to think about it not beat the market just be the market funds we like to do that so like you know u.s large cap is a great example we think just buying the low-cost practically free index makes a lot of sense but perhaps there are some asset classes that are a little bit more unique you know you can think about even right now in a very low interest rate environment where some people think rates are going to go up and some people think rates are going to go down and some people think you ought to be on the short end and some people think you'll be the long end of the curve and we have a lot of quantitative easing we have a lot of government paper being printed maybe you don't want to be in like a fixed income index perhaps active managers could be better positioned to navigate that environment well you could say the same sort of thing in the real estate market perhaps with the way that e-commerce is changing real estate perhaps active management inside real estate makes more sense than passive management the point that we're making is when it comes to portfolio construction design we're not so dogmatic that it's all one or all the other but in the places where we do choose to go active we have a reason for doing that and that reason usually is not because we want to beat the market it's not because we think we have some prowess we can do that it's because something is taking place maco macroeconomically that causes us to want to shift assets in that direction well distortions that's what you just like when you you mentioned quantitative easing if you go look at index funds in the bond sector once we continued watching the government go back to pumping so much money out there you're going to notice it's all all the indexes are going to be all governmental indexes it's not going to have a lot of diversification you'll also talk about distortions talk about real estate if you know everybody's now doing amazon and we see all these malls sitting out there and traditional big box retailers that's going to create some weird distortions in the in the re in the retail sector so you need to pay attention to those things but you do need to make sure that if you are paying for an active manager they better be performing and they better be even overcoming the tax limitations because realize index funds since they don't trade so much they're much more tax efficient meaning your year-end distributions are substantially lower you just want to make sure that you're making a lot doing a lot of research a lot of due diligence because a lot of times while you're talking about international whether you're talking about domestically the index funds do incredibly well and they take a lot of the guesswork they lower fees there's not that headwind it's a good thing to look at the index funds in a lot of ways if you can go the cheaper route so i want to repeat what i just heard you say brian when it comes to like active and passive it's not either or it's potentially both and depending on the circumstance wouldn't you say the same thing can be said for mutual funds versus etfs it's not either or it's most likely of both and depending on your individual circumstance and what you're trying to accomplish and we've talked about like i love index target retirement funds for those under half a million dollars because it does let you focus on the savings and lets them focus on the asset allocation because they go from aggressive to more conservative as you go through the years but it's like that with the individual investors you are going to reach a level of success after 500 000 you'll need the additional exactly right attention you'll need to go ahead and look at tax loss harvesting you know tax location you know all these things that come into play that it's just better to have a more custom route than just buying the all-in-one target retirement fund and so i think brian that's a beautiful segue because as we were sitting down thinking about okay well obviously the listeners are going to want to know well how do i decide you know when does a mutual fund make sense when does an etf make sense well we said well let's think about some of the unique financial planning opportunities that we do for clients sort of on a regular basis or things we look at year to year and kind of share some of those so that you guys can use that as you think about how you build and construct your portfolio so let's i want to jump right into these because i think the first one when i'm thinking about unique planning opportunities capital gains should come into play because we talk about what is the tax impact of what's going on here capital gains like if we have somebody who's brand new brand new client they come to us in fourth quarter if you go buy a just portfolio full of mutual funds you have to be careful because there might be some embedded capital gains that will be distributed out that you don't want your client signing up going and investing in portfolio and then getting a big tax bill at the end of the year when they've only been participating for a short period of time you know this is a common misnomer that i hear all the time so i'm going to say hey bo yeah i saw this fund and you know if i hold this fund on december 5th they're going to issue a 14 capital gain distribution doesn't that mean i'm gonna get a 14 rate of return if i own it on that day no all you get is the tax bill it's actually a net neutral zero event they decrease the value of your holding and you just get to pay the taxes on it so if you can avoid those you those large distributions of mutual funds at the end of the year it likely makes sense to do so so just to make sure you all hurt him they adjust the price that mutual funds trade at for those distributions so don't get excited thinking hey i'm gonna go buy this fund the day before they they record the investors of record and then i'm gonna get make 14 just because i bought in no they'll lower the price of your investments yes you will still that's why it ends up being a neutral event but you are going to pay the taxes on that income so so pay attention to that but look it cuts the other way we just came to a bear market there's a chance if you went on morningstar and looked at values as of 331 there might be a group of mutual funds out there that are trading at a discount meaning that if you look at are there embedded losses that are within their portfolios that means you could buy into a mutual fund and maybe it could make 10 to 15 before it gets back to break even where you're gonna have ten to fifteen percent of gains before distribution everybody come into play it's a great they've actually done i mean this isn't really what they did but they kind of did some lost harvesting for you we did a ton of this in 2009 at the beginning of the year we'd actually go screen our mutual funds and if there was a 30 or 40 embedded loss and we felt like that fund was positioned well to perform well moving forward we'd absolutely go grab that then we kind of had a tax free ride for that first 20 or 30 percent that planning opportunity only works coming out of down markets now realize markets typically make money 8 out of 10 years so more than likely you have an embedded gain in your mutual fund not an embedded law right but it is there are some unique times twice every decade usually we just came out of one that there might be some embedded losses and in those situations a mutual fund with an embedded loss is better than an etf because every dollar you make from the day you invest with the etf you're going to pay taxes as it gains if you have an embedded loss on the mutual fund you might have a head start before you have to start paying the tax man so pay attention to that and then you know those are those some of the big things that are going on but let's talk about the intraday pricing yeah so one of the things uh that is a benefit is you have some hands-on control over the price that you trade right so you know again we just came through this covet 19 thing and there were days where the market would open up down six or seven percent the client would comment hey the market's down let's buy well if we actually behaved in that way it would if we put in a mutual fund trade we wouldn't actually be capitalizing on that because the mutual fund doesn't trade until the end of the day if you wanted to capitalize on the market being down in the morning you'd have to buy an etf to do that well intraday pricing allows you to have a little more control over the timing of the trades that you're placing now i'm going to sound a little bit maybe it's because i'm getting older i'm more like jack bogle is i think that those price fluctuations throughout the day tend to push you more towards the speculative side of investing versus the fundamental side and let me this is the part i alluded to it earlier we went on a 40 minute i had two slides built into this presentation explaining the distortions of mid to late march with bonds bond etfs specifically the team made me throw out these slides because they were worried you guys were gonna go to sleep so i'm just gonna try to do a really good job of summarizing this march 18th 19th 20th i mean you probably could throw in the 20 there's a lot of crazy things going on in the equity marketplace that was bleeding over into the bond etf marketplace so what we saw was we saw if you were buying a bond etf of like the ag agg the price fluctuation throughout the day could have been as high as four to four and a half percent in one single day of trading the price moved that much on a bond etf and then think about day two because put two days together another four to five percent fluctuation if you were the worst investor or unluckiest investor you potentially could have a 10 fluctuation on your risk off bond fund when really the bond fund traded in less than a 1 trading ban if you were buying the mutual fund so inherently if you are trading etfs because of those price distortions even taking away from from just generally the asset class you're investing in you are naturally adding risk to your portfolio just because of how much does fluctuate those prices can fluctuate interest now fortunately this is the other second slide that y'all made me take away the majority the lion's share of the time ninety percent of the time etfs trade within the ending value of the the nav value of this their brethren that are mutual funds so it's not a this this is only in unique distorted times i'm just saying that if you're an investor and you're looking at your investments from what's risk on like equities risk off like cash and bonds or fixed income you might need to think about that extra level of risk or volatility because you might be counting on this money to be super safe but then you find out it's got four to five percent price fluctuations just because of the intraday pricing that's just something you ought to take into account because it is exactly what both said it pushes it further out on the wrist spectrum than what you might have been anticipating when you bought the product that's exactly right was that better than the two that was so much better than the two slots do you agree so much how did we talk about that for 40 minutes before we poor daniel i had him trading changing slides we'll just we'll keep it going but that probably did sound better than the two slides i had uh the next planning opportunity so well here's the planning opportunity from that just because you can trade intraday you probably shouldn't do a lot of intraday trades when there's wild volatility especially inside of etfs because potentially what you're trading you're getting more than you bargained for i just put a nice little bow on that all right so let's talk about the third one uh loss harvesting and this isn't necessarily now tell me you might disagree with me i don't think this is a ets versus a mutual fund i think this is just a tactic that you can use but loss harvesting is something well let me say first of all definition okay loss harvesting all that means is within your taxable accounts not your retirement accounts but your taxable accounts if you have a loss you can lock it in and turn that loss to where it becomes a paper loss that you actually take a tax deduction for our offset gains in the future you know now here's where i think why we put this in here etfs gets some special treatment in the fact that it's much easier like you could sell the spy and then go buy the total bond another etf or a total bond i mean total total stock market index fund and you you essentially even though you sold the s p 500 etf you've it's enough difference there that you could probably block in the loss yeah one of the strategies that we were able to employ in the first quarter of this year is that the market fell so rapidly so quickly normally we're able to loss harvest i don't know maybe one time a year and down years well what it allowed us to do is we could have an index-esque fund and the market could drop and we could lost harvest and sell that fund and go buy a materially different fund but inside the same asset class well then the market would fall further inside of 30 days we couldn't go buy the original fund we had to have a stable what etfs have allowed us to do is build a stable of similar but materially different etfs that we can lost harvest across with mutual funds at least in our expenses it's been a harder thing to do ets might allow you to do that now here's what you really want to do have a stable of both and then you can kind of control what exposure you're doing that's how you end up having a very tax efficient portfolio long term now a lot of people because i've had a few people question us when we've done episodes on lost harvesting they'll be like but don't you end up in the same place i mean if you're selling a thousand dollars turns into five now look i'm using super maybe i should use a bigger number let's do a hundred thousand dollars goes down to fifty thousand but then back up to a hundred if you did absolutely nothing your hundred thousand dollars still is a hundred thousand dollars went down went up the difference with a loss harvest is you go down to 50 you lock in the 50 000 loss you buy another equity type investment that's different enough that you can take the paper loss it goes back up to a hundred yes now you have an embedded gain of fifty thousand but you have a paper loss of fifty thousand you are in the same place here's the difference you're holding for years so when you file your taxes in april you're going to be able to actually turn a portion of that loss into a tax deduction that will lower your taxes absolutely the guy who did absolutely nothing not going to be able to turn that into it the other thing is if you're charitably minded if you sold low and now you reinvested and now you've got this essentially 100 gain on the the purchase when you bought when it was low if you gift that to to a charity that's our taxes you get the tax max deduction for the market value it's just a great planning opportunity so that's that's why we're talking about unique planning things you can do that's a little more sophisticated but definitely takes advantage of it and etfs do give you some additional absolutely tools there let's pivot now to because i don't want to just pick on my mutual fund friends you know we need to say mutual funds have a place too how about automatic dollar cost averaging yeah this is the one we've already kind of alluded to this if you are someone who wants to set up an automatic dollar cost averaging plan where every month i want to have a hundred dollars 250 500 fill in the blank and you want to just have that going you don't think about it you don't look at you just have it automatically purchase mutual funds are going to be the best way to do that it's much more difficult to do that with etfs in my experience so i've had folks said no no i only want to invest in etfs i'll just send a teaser that every month on the 10th i'll just go in and buy a hundred dollars that etf yeah that's easy to say until the day that you go and to buy maybe the market's down really really bad and you're like oh i don't know about that when you should be excited or worse what the market's up a lot that day by using mutual funds you remove some of that emotion you don't have to think about it you have to figure out when to buy when not to buy you just set it and let it automatically start working that's one of the reasons we love whenever we set up automatic dca plans we do it mutual funds so you don't even have to worry about it so we got kind of fancy with some of our retirement plans put some etfs in there then a lot of the 401k providers came back and said we're not doing that we're not doing this mutual funds are so much easier because of all the things we just talked about with automatic systematic savings plans mutual funds are just easier that's right so that's why think about that when we're talking about the pros and cons but it is one of those things that i think definitely leans more towards the mutual fund all these things i know we started this talking about the conflict we have even jack bogle talking about wolves and sheep's clothing i wanted to make sure i got that right wolf and sheep and sheep's clothing you know that's what because that's the way he described etfs because they were kind of getting into the territory of his sacred index funds and index investing but i think we've as we've shared in today's show there's actually a place for both you just need to know what each one does well what each one has limitations in and then make sure you're just marrying the perfect combination for what your financial situation needs that's exactly right we think there's just two different tools in your tool belt that can make sense in different situations when you say tool belt makes me think that we should have worn i could have worn my batman shirt and you could have worn the the robin shirt again and it could have been the the you know we could have done batman and the boy wonder oh you know what i'll at least take like tim the tool man taylor and al borland i would even take that one hey speaking speaking of tools the greatest thing i've ever done is make us do the batman and robin show i love it because it just is the joke that keeps on giving hey if you haven't uh seen that show you should go check out money guy superhero show 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Channel: The Money Guy Show

Views: 37,607

Rating: 4.916883 out of 5

Keywords: money guy show, debt, budget, cash, real estate, insurance, how to make money, save, credit card, compound interest, buying house, buy stock, success, personal finance, The Pros and Cons of Mutual Funds and ETFs (Which Option is Best?)

Id: T8rcOp2nZMk

Length: 44min 36sec (2676 seconds)

Published: Fri May 22 2020