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How do ETFs and Mutual Funds Fit into a Comprehensive Financial Plan?

By Ron Ross | December 11, 2015

Ever wonder about the difference between ETFs and mutual funds -- and especially how those differences fit into your wealth management strategies? If so, you're not alone: Our wealth advisors get asked about exchange traded funds or ETFs and mutual funds every day, especially by clients seeking retirement investment advice.

Ron Ross is a CFP, Certified Financial Planner and a 401(k) Financial Advisor with Premier Financial Group in Eureka Humboldt County

While these two investment vehicles may share a few similarities, each offers its own distinct advantages and disadvantages, depending on factors such as your financial goals, fees and costs, tax implications and accessibility. Read on to learn about ETFs and mutual funds so you can decide which is right for you.  

Mutual Funds and Strategic Wealth Management

In a nutshell, mutual funds consist of pools (or baskets) of bonds or stocks, all chosen by a fund manager. Once the exclusive domain of high-end investors who had the means to hire professional retirement plan advisors, mutual funds are now available to investors at all income levels and -- with about $9 trillion in assets -- there’s something for everyone.   

Unlike stocks, mutual fund prices don’t vary during the trading day; rather, prices are set at the end of the day, based on the prices of the individual stocks and bonds contained in a fund.  Mutual funds come with a price tag attached. Costs usually run from 0.1% to 3% annually and may include:

  • Commissions, a.k.a.. loads – paid when you buy or sell shares

  • Redemption fees – paid when you sell early.  Keep in mind that this is not all of the investor may pay in fees.  They can, for example, pay account fees, transaction fees, investment fees, management fees to their advisor, and more!

  • Operational expenses – manager’s fee and miscellaneous costs such as marketing or distribution

ETFs and Strategical Financial Planning

Like mutual funds, ETFs consist of baskets of individual investments. Unlike mutual funds, ETFs trade during the trading day at a price that’s determined by investor demand.  Another difference? ETF operating expenses are lower, as they don’t include loads. Here's a breakdown from FINRA: 

Fund Type

Average Total TOT 0.37% Operating Expenses

Mutual Funds

ETFs

US Large-Cap Stock

1.31%

0.47%

US Mid-Cap Stock

1.45%

0.56%

US Small-Cap Stock

1.53%

0.52%

International Stock

1.57%

0.56%

Taxable Bond

1.07%

0.30% 

Municipal Bond

1.06%

0.23% 

 An exception to the table above would be Institutional Mutual Funds similar to the ones that Premier Financial Group uses through Dimensional Fund Advisors.  These Institutional Mutual Funds, not readily available to the average investor, can have much lower costs and have very competitive fund costs as compared to ETFs. 

Buying ETFs -- How Does it Work?

Ron Ross is a CFP, Certified Financial Planner and a 401(k) Financial Advisor with Premier Financial Group in Eureka Humboldt CountyETF prices are based on a bid price (from buyers) and an ask price (from sellers) so when you want to invest in ETFs, you have to figure how many shares to buy.

  • First, consider the bid and ask price; you’ll likely pay somewhere in between.

  • Determine the amount of shares to buy by dividing the amount you want to invest by the ask price.

  • After the order is filled, you’ll discover how much you actually paid.

  • The difference between the highest acceptable bid price and the lowest acceptable sell price is known as the spread; it may as low as a penny (for widely traded ETFs) or much higher (for less-liquid ETFs). 

  • You’ll pay both the spread and a transaction fee to the custodian.

If you're unfamiliar with spread, ask your private wealth advisor to explain the details. 

Tax Implications for Your Comprehensive Financial Plan

ETF’s can make capital gains management a little easier as well.  Mutual fund managers buy and sell underlying securities at various times throughout a given year.  If these trades realize capital gains, the owners of the funds get the tax passed on to them.  Because the funds are managed and traded directly with the fund, there is no way for you to control this.  Be cautious when purchasing municipal funds -- gains are still taxable!  ETF’s, on the other hand, are traded like stocks over an exchange.  The owner of the ETF controls the sell, and in turn, the realized gain or loss.

 
   
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