Speaker 1: For nearly a century, when investors wanted a professional to
Speaker 1: manage their stocks or bonds, they turned to a tried
Speaker 1: and true vehicle mutual funds. But over the past few decades,
Speaker 1: the mutual fund has been losing the battle for investors' attention,
Speaker 1: primarily to exchange traded funds, but also to things like
Speaker 1: separately managed accounts and direct indexing. Does this mean we're
Speaker 1: at the end of the famed mutual funds? Four one
Speaker 1: ks and mutual funds and mutual funds and exchange traded
Speaker 1: fund mutual funds and other investments? Everything is down on
Speaker 1: mutual funds.
Speaker 2: I think most mutual funds, many mutual funds and index
Speaker 2: funds that are owned by consumers.
Speaker 1: I'm Barry hilt and on today's edition of At the Money,
Speaker 1: we are going to discuss what fund wrapper is best
Speaker 1: for your capital. To help us unpack all of this
Speaker 1: and what it means for your portfolio, let's bring in
Speaker 1: Dave Nadig. He is financial futurist at Vetify and a
Speaker 1: well known ETF industry pioneer. So, Dave, I'm gonna throw
Speaker 1: another of your quotes back at you. If the mutual
Speaker 1: fund was invented today, it wouldn't get regulatory approval, absolutely not.
Speaker 2: Explain well, the key thing about a mutual fund that's
Speaker 2: different from an ETF is primarily how the money gets
Speaker 2: in and out and then how it's taxed. And the
Speaker 2: reason mutual funds are inherently at this point an inferior
Speaker 2: structure to ETFs for almost everything is how that money
Speaker 2: gets in and out. So when you put money in
Speaker 2: a mutual fund, Barry, you send money virtually to say Fidelity,
Speaker 2: and then they take that cash and then they go
Speaker 2: buy a bunch of stocks, and then when you want
Speaker 2: to take your money out, they say, oh, Berry wants
Speaker 2: his money back, They sell a bunch of stocks and
Speaker 2: they give your cash. It can be a little bit
Speaker 2: more complicated than that, but.
Speaker 1: That's a core aspect. You send them cash and they
Speaker 1: go out to the marketplace and make purchases on your
Speaker 1: behalf within the structure of everybody else in that fling exactly.
Speaker 2: And that sounds great and it's a fantastic structure. It's
Speaker 2: actually been going back since the fourteen hundreds in the
Speaker 2: Dutch East India company right that kind of pooled mutual
Speaker 2: structure very straightforward. The problem is when you decide to
Speaker 2: sell the tax bill for any gains and selling all
Speaker 2: those stocks so you can get your one hundred million
Speaker 2: dollars back. That tax bill notionally gets applied to the
Speaker 2: entire pool. Now it's not as bad as it sounds.
Speaker 2: I don't have to pay taxes that I never get
Speaker 2: back just because Berry is sold. However, I will have
Speaker 2: to deal with that this year. Left to just my basis,
Speaker 2: I will get a distribution. I'll get a taxable gain
Speaker 2: that shows up on my IRS report even though you
Speaker 2: didn't sell without selling a darn thing. So anybody who's
Speaker 2: owned a mutual fund and a taxable account knows this.
Speaker 2: You get a distribution you didn't sell anything. Some of
Speaker 2: that's dividends from stocks or coupons from bonds, but some
Speaker 2: of it's just, hey, we bought and sold some stuff.
Speaker 2: We have to pass that out every year. That's the
Speaker 2: rule the IRS has. And by passing that out, you
Speaker 2: mess with every holder of that fund's axis for that year,
Speaker 2: and they take away a timing benefit because you have
Speaker 2: to recognize that this year even though somebody else sold.
Speaker 1: So now do a compare contrast with an ETF. How
Speaker 1: is it different in terms of capital gains distributions.
Speaker 2: The primary difference is that the ETF is rarely buying
Speaker 2: and selling anything on behalf of the whole pool. When
Speaker 2: new money comes into the fund, it's because Barry, you
Speaker 2: went out, you bought one hundred million dollars. You caused
Speaker 2: it to be a little more expensive. That makes these
Speaker 2: other folks, these authorized participants that you never have to
Speaker 2: worry about, do the actual creation of new shares of
Speaker 2: the fund you want with the issuer, and they do
Speaker 2: that by buying all those stocks and just handing them
Speaker 2: over to the fund. The same thing happens in reverse,
Speaker 2: and because no sale happens with big air quotes around it,
Speaker 2: it's all happened in kind. The IRS doesn't treat that
Speaker 2: as a taxable event.
Speaker 1: Explain in kind in other words, So with a mutual fund,
Speaker 1: I'm literally selling here's one thousand dollars, and they say
Speaker 1: we have one hundred stocks. Are gobat and buy a
Speaker 1: thousand dollars worth of stocks. Literally, It's that simple. When
Speaker 1: you say in kind transaction, how is it different with
Speaker 1: an ETF.
Speaker 2: Well, from the individual investors perspective, you just buy an
Speaker 2: ETF like a stock, So it's really simple. You buy it,
Speaker 2: you sell it, easypasy.
Speaker 1: So then how do these funds get created? If I'm
Speaker 1: buying something that's trading every day.
Speaker 2: Well, if enough people are buying at the same time,
Speaker 2: the price of the ETF will go up a little bit.
Speaker 2: When it goes up enough so that it's actually a
Speaker 2: little bit overvalued compared to the underlying basket of stocks.
Speaker 2: These arbitrajurors step in and they create those shares and
Speaker 2: they're allowed to. There's a whole system for that that
Speaker 2: is an individual investor you don't have to know about.
Speaker 2: But the end result is the tax liability gets washed,
Speaker 2: it gets pushed forward into the future. So your spy holdings,
Speaker 2: you're not going to get capital gains distributions. You might
Speaker 2: still get dividends, that's still going to happen, but your
Speaker 2: capital gain is going to be based on when you
Speaker 2: choose sell it. So if you buy it at four
Speaker 2: hundred and sell it at five hundred, you have a
Speaker 2: personal one hundred dollars gain that you report on your taxes.
Speaker 2: It's very clean, it's very simple, and it's tax efficient
Speaker 2: and tax fair.
Speaker 1: So that that seems to be one reason why ETFs
Speaker 1: are attracting a lot of capital that previously we're either
Speaker 1: flowing to mutual funds or as we've seen, come out
Speaker 1: of mutual funds and head headed to ETFs. Before we
Speaker 1: get to enthusiastic about exchange traded funds, what are the
Speaker 1: downsides of these?
Speaker 2: Well, you do have to know how to trade, right,
Speaker 2: and if you're not comfortable buying and selling Microsoft stock,
Speaker 2: you should not be out there by buying and selling
Speaker 2: spy the S and B five hundred spider because it
Speaker 2: has the same issue in the sense that there's a
Speaker 2: price you pay to get it, then there's a price
Speaker 2: you pay when you sell it. Then there's a gap
Speaker 2: in that and if that gap is very wide, that
Speaker 2: spread is very wide, then that's friction on your on
Speaker 2: your and that's all return right, So that's it's sort
Speaker 2: of a hidden cost to trading. So I always say
Speaker 2: you need to be comfortable with trading hygiene, right, you
Speaker 2: need to understand the basics of how to get a
Speaker 2: trade in how not to get messed up there. Then
Speaker 2: it's really straightforward. That's the primary issue. The other thing
Speaker 2: I think investors can get a little over their skis
Speaker 2: on is because we have so many ETFs in the
Speaker 2: market now, and the structure is incredibly flexible. You can
Speaker 2: get access to all sorts of stuff that may or
Speaker 2: may not actually belong in your portfolio. You want triple
Speaker 2: leveraged inverse oil futures, you can get that in an
Speaker 2: ETF wrapper. You probably shouldn't.
Speaker 1: Okay, right to say the very least. So if the
Speaker 1: downside to owning mutual funds is these phantom capital gains,
Speaker 1: that suggests that if you have a tax defert account,
Speaker 1: a four oh one k, an ira four h three
Speaker 1: be anything like that, mutual funds probably can live very
Speaker 1: comfortably in those sort of accounts.
Speaker 2: Absolutely. And you know, in my own personal portfolio, I
Speaker 2: use a whole bunch of index mutual funds that happen
Speaker 2: to be available in those retirement plants, and they do
Speaker 2: a great job, and there's no reason not to have
Speaker 2: them there. And in fact, there are some reasons why
Speaker 2: mutual funds are better in that environment. Most people who
Speaker 2: contribute to their I R or their four to zoe
Speaker 2: K don't think about it in shares. They think about
Speaker 2: it in dollars. You know X percent of my paycheck.
Speaker 2: Now I've got three hundred and eighty dollars more in
Speaker 2: my four ROH one k, you want that three hundred
Speaker 2: and eighty dollars split into whatever funds you had. But
Speaker 2: if you were doing that in ETFs, you have to
Speaker 2: buy an individual share, which might be twenty five or
Speaker 2: one hundred and twenty five dollars for one share. It's
Speaker 2: very noisy. You're not going to be able to make
Speaker 2: your allocation perfectly. Mutual funds don't trade that way. They
Speaker 2: trade in fractional shares to the fifth decimal point. So
Speaker 2: even if you're trying to get a dollar to work,
Speaker 2: you can split that dollar across five different funds.
Speaker 1: Wow, that's interesting. So is it a little premature to
Speaker 1: say that we're looking at the death of mutual funds?
Speaker 1: Is it more accurate to say these things are evolving
Speaker 1: and ETFs and mutual funds are all serving different purposes.
Speaker 2: I think that's the world we're headed toward. The old
Speaker 2: phrase I like to use is, you know, different horses
Speaker 2: for different courses. You know, put the horse racing vets
Speaker 2: on it. You know, there are some use cases, particularly
Speaker 2: around retirement. As you highlighted. The other sort of edge
Speaker 2: case in mutual funds is sometimes you want to close
Speaker 2: a fund if you're a small cap special situations manager,
Speaker 2: you may not be able to run ten billion dollars
Speaker 2: the way you could run two hundred million dollars, So
Speaker 2: you cap it two hundred and you close it. And
Speaker 2: in fact, a lot of the best performing mutual funds
Speaker 2: out there, year after year are closed to new money.
Speaker 2: And that's because somebody has some sort of edge, usually
Speaker 2: in an active management context, and they can only express
Speaker 2: that edge at a certain size. You cannot do that
Speaker 2: in an ETF. You can't close an ETF for new
Speaker 2: money because that whole mechanism we just talked about about
Speaker 2: buying and selling it in the market. That'll get haywire
Speaker 2: because now you can't make or get rid of any
Speaker 2: of them.
Speaker 1: So let's tie all this up together. Mutual Funds have
Speaker 1: been around for forever. Practically the Forties Act nineteen forty
Speaker 1: is the legal documents that created what is essentially the
Speaker 1: modern mutual funds. Typically, what we've seen over the past
Speaker 1: few decades is the rise of a lot of alternative
Speaker 1: wrappers to purchase stocks and bonds, and as an investor,
Speaker 1: you need to think about what sort of holding you
Speaker 1: have in order to figure out where to locate those assets.
Speaker 1: If you're an active mutual fund that has a lot
Speaker 1: of transactions and a lot of phantom capital gains taxes,
Speaker 1: well that's something you want in a four oh one
Speaker 1: K or an ERA. If, on the other hand, you
Speaker 1: are holding something in your portfolio that's not tax deferred, hey,
Speaker 1: that's the perfect opportunity for an ETF, and a lot
Speaker 1: of fun companies will offer you both whatever you want.
Speaker 1: You want the S and P five hundred, you get
Speaker 1: that in ETF, you can get that in mutual fund.
Speaker 1: Just about all of the big companies offer parallel mutual
Speaker 1: funds and ETF these days. Be careful about where you
Speaker 1: put those funds. It'll make a big difference to your
Speaker 1: tax paym and your bottom line. You can listen to
Speaker 1: At the Money every week finding in our Master's and
Speaker 1: business feed at Apple Podcasts. Each week we'll be here
Speaker 1: to discuss the issues that matter most to you as
Speaker 1: an investor. I'm Barry Rittolts. You've been listening to At
Speaker 1: the Money on Bloomberg Radio