In this episode of “Investment Management Foundations,” Gary Quinzel, Vice President of Portfolio Consulting at Wealth Enhancement, discusses some of the differences between investing in mutual funds, exchange traded funds (ETFs), and individual stocks.

VIDEO TRANSCRIPT BELOW

Hello everyone. Thank you for joining us on this episode of “Investment Management Foundations.” My name is Gary Quinzel. I'm the Vice President of Portfolio Consulting here at Wealth Enhancement Group. Today, we're going to talk about some of the differences, including pros and cons, of different security types. More specifically, I'll be talking about mutual funds, exchange traded funds, often called ETFs, and individual stocks. All have benefits, as they can help build long-term capital and pay dividends, but there are some really distinct differences that can make a big difference on after-tax returns.

First, let's just look at the diversification benefits, because diversification is one of the most important elements from a portfolio construction standpoint. Mutual funds are pooled investments. They combine lots of individual securities, typically individual stocks or bonds, and they can be actively managed, which means there's an underlying investment manager that will trade those on an active basis, usually differing from an underlying index. ETF exchange traded funds also are pooled investments in that they hold large pools of underlying investment, but more times than not, they are more passive in nature, which means they are tracking an underlying index. Now, there are exchange traded funds that are more actively managed or follow distinct strategies, such as factor based, but either way, you can get broad diversification for mutual funds and ETFs. Individual stocks, on the other hand, represent one individual company, and you don't get diversification from that.

Let's next look at how they're traded. Mutual funds are traded once per day. There is no intraday trading with ETFs and individual stocks; they're both traded in real time every single day, from 9:30 a.m. to 4 p.m. Eastern time. So, based upon your mechanism for trading, you can get real-time pricing and take advantage of daily fluctuations. They're also traded on exchanges, which are backed by notable exchanges such as the NYSE NASDAQ and many, many others, which add additional transparency about trading.

Let's talk a little bit about fees. One of the benefits of exchange traded funds over mutual funds is that they often have lower investment manager fees, many times because they are passively managed. Mutual funds also have investment management fees that, if they're actively managed, tend to be a little bit higher. But with individual stocks, there's no additional layer of fees, so from a cost perspective, it can add up over time.

Let's talk a little bit now about tax efficiency. One of the knocks on mutual funds is often that they are not very tax efficient vehicles. The reason for this is that they can pay out capital gains distribution, often on an annual basis, regardless of whether that mutual fund was up or down during that year. Exchange traded funds, on the other hand, can be exchanged in kind. So, no matter how big a purchase you are making or sell off an ETF, the underlying components can be exchanged in kind by what's called an authorized dealer, and they can actually create or redeem in kind shares, which avoid having a taxable event. Individual stocks are also considered to be tax efficient for multiple reasons. If you're trading individual stocks on a frequent basis, it can lead to tax inefficiency in short-term gains. However, if you are a buy-and-hold investor and you're holding individual stocks for a long time, the dividends that are paid out are typically qualified, which means they're taxed at more favorable rates. And if you hold stocks for more than a year, the gains are considered long-term capital gains. ETFs track indices, as we mentioned, so once again, it's a great way to capture long-term gains within a market. It's a very low cost, easy way to get diversification and reap the benefits of the stock market going up over time.

We hope you found this rundown of the different security type useful, and please join us again for future episodes of “Investment Management Foundations.”

This information is not intended as a recommendation. The opinions are subject to change at any time and no forecasts can be guaranteed. Investment decisions should always be made based on an investor's specific circumstances. Investing involves risk, including possible loss of principal.

2024-5024