Wealth Management & Financial Planning

Wealth Management & Financial Planning

Not Every Basket Is Created Equal

Knowing which basket to use is essential when engaging in activities like picking apples, or shopping at the grocery store. The same is true when evaluating your investment portfolio.

The most common “baskets” used for investing today are mutual funds and their younger counterpart, exchange-traded funds (ETFs). They have similarities, but often more differences than common investors realize. You must look at the details to fully understand which basket is right for you.

As of today, mutual funds are still the largest investment option, but the ETF market has continued to grow at a feverish pace. Keep in mind, the largest holders of exchange-traded funds are the mutual fund companies themselves.  Why would that be?

A mutual fund company is required to tell you the top 10 holdings in the fund each quarter. The funds often have more than 100 holdings, so the transparency is limited.  The majority of ETFs are passive in nature, meaning no consistent investment management takes place inside of the fund.  Because passive ETFs have such limited trading activity, you know what you owned from the first day it was purchased.

Inside of a mutual fund, a substantial turnover of the holdings occurs, especially in a volatile market. This creates costs from the fund manager, and at times can create unwanted tax consequences. This manifests itself in the form of phantom gains, whereby you are forced to pay capital gains on positions you never sold.

On the flip side, ETFs not only provide transparency but also efficiency.  The number one traded ticker symbol on the New York Stock Exchange is SPY.  That is the S&P 500 index traded in one ticker symbol.  It is hugely efficient for investors and mutual funds alike.

The big question is, if ETFs are more transparent, cheaper in expenses, and even have tax advantages, why has the investing public stayed with mutual funds?  We believe this is due to a multitude of reasons, some of which can be a lack of awareness, lack of understanding, or significant barriers to change. For example, most 401(k) plan providers have significant incentives to keep mutual funds as the only choices on their platforms.

Perhaps you own a joint or individual account where large capital gains have accrued, and you don’t want to pay the taxes that would result from making to make the change to ETFs.  Good news, because of the recent market volatility, now may be a good time to visit making the transition from mutual funds to ETFs.

Thanks to the trading costs arms race in 2019, most major investment shops removed or reduced trading costs for the common investor. Coupling the reduction in trading costs with the current market volatility, now could be a great time to evaluate your current portfolio and ensure you have the right basket for the job. With that said, you will always need to evaluate your risk tolerance, fees, and time horizon when selecting an investment vehicle.

If you have questions about ETFs, contact the Financial Enhancement Group at yourlifeafterwork.com.

The Financial Enhancement Group is an SEC Registered Investment Advisor. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.

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