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Distinguishing Exchange Traded Funds (ETFs) from Mutual Funds
Keith Fevurly, Investment Advisor, Integra Financial Inc. • June 3, 2020
Mutual funds and exchange traded funds are types of professionally managed assets, but there are major differences. First, a mutual fund (or its proper name, “open end investment company”), is priced only at the end of the trading day, when its “net asset value” (NAV) is determined. The NAV of any mutual fund is computed by taking the portfolio’s total market value at the end of any trading day, then subtracting any fund liabilities, and, finally, dividing the resulting number by the number of outstanding shares in the fund. The fund is said to be “open ended” since it continually offers new shares to investors and remains ready to buy back outstanding shares from investors. Alternatively, an exchange traded fund (“ETF”), trades like a stock, meaning an immediate price is obtained when there is a trade of the share (or more properly, the “depository receipt”). While the ETF is also valued according to its NAV at the end of the closing day, the more relevant value is its “intraday NAV”, the difference between its NAV and market price.
The key to properly diversifying a portfolio is to diversify “across and within” sectors of the market. There are 11 sectors of the market as follows:
A second major difference is the type of assets in which a mutual fund invests as compared with the ETF. There are numerous categories of mutual funds depending on the fund’s investment objective, but generally these categories are listed as part of a fund that invests solely in stocks or bonds or a combination of stocks and bonds, referred to as a “balanced fund”. A notable separate type of mutual fund is an “index fund” or a fund that invests only in the shares of a major index such as the Standard & Poor index of 500 stocks (“S&P 500”). Alternatively, an ETF typically invests solely in index funds. Indeed, an ETF is often described as an “index fund that trades like a stock”.
A final major difference is that most mutual funds (with the notable exception of the index fund) are managed “actively”. If the fund portfolio manager practices “active management” techniques, it means that the manager or investment company is attempting to outperform a broad market index, such as the S&P 500 Index of stocks, on a longer term or more-than-one-year performance basis. Alternatively, most ETF’s are managed “passively”. At the heart of “passive management theory” is a belief that any market or stock exchange is “reasonably efficient”, meaning that there is no immediately apparent way to outperform the broad market index. As a result, an ETF manager attempts only to match the market index and does not trade the portfolio’s holdings nearly as frequently as an “active manager”, thereby resulting in lower costs to the investor.
An investor’s annual total return, both in terms of dollars and percentage, from a professionally managed asset, such as a mutual fund or ETF, is heavily dependent on the fees charged to manage the portfolio. For example, if a fund imposes a management fee of one percent (1%) of its total NAV to manage the assets, an investor must achieve an annual return of at least one percentage more than the return the market index returns. Moreover, if the investment advisor charges a fee of an additional one percent to select the fund and manage the investor’s individual portfolio, the “bar” to overcome is now at least two percent (2%) more than the performance of the market index. Studies have shown that over a long period of time, for example 10 or 20 years, the recovery of these fees by the investor is extremely difficult to recoup. Thus, the greater the fees imposed by the fund or advisor, the more difficult it is to accumulate wealth over time.
A major advantage of the ETF form of professionally managed assets is its fee structure, resulting in a relatively low amount of fees imposed on the investor. In part, this is because a fee is only incurred if the underlying assets in the ETF are traded (bought or sold). Since the ETF is managed “passively”, and trading of its underlying assets is relatively infrequent, a fee advantage over the mutual fund results. Still another way in which ETFs achieve a fee advantage is because of how the ETF trades. Specifically, as mentioned previously, an ETF trades its shares like a stock. Accordingly, the sale of an ETF share from one investor to another has no impact on the value of the overall fund. Conversely, when a mutual fund shareholder sells his or her shares, they must be “redeemed” (bought back in cash) from the investor. Sometimes, this requires the mutual fund to sell shares to raise cash to cover the cost of the redemption. As a result, the operating expenses of the mutual fund are typically more as compared to the ETF.
For an individual interested in investing in a professionally managed asset, the question arises: “Which is best, the mutual fund or the ETF”? A related question is: In which category of mutual fund or ETF, such as stocks or bonds, should an individual invest? However, before answering these questions, an individual should understand that both mutual funds and ETFs provide a major advantage over individual stocks and bonds: that of, instant diversification. Diversification is the art of constructing a portfolio to exhibit less total risk without experiencing an equal reduction in expected return. The construction of a fully diversified portfolio is the major benefit that a portfolio manager and investment advisor “brings to the table” and how the advisor in part “earns his fee”!
The key to properly diversifying a portfolio is to diversify “across and within” sectors of the market. There are 11 sectors of the market as follows:
• Technology
• Financials
• Utilities
• Consumer Discretionary
• Consumer Staples
• Energy
• Healthcare
• Industrials
• Telecom
• Materials
• Real Estate
An individual can invest in a sector-specific mutual fund or ETF, but if doing so, has achieved only diversification “within” the sectors of the market. Rather, to achieve further diversification “across the market”, he or she should invest in several mutual funds or ETFs.
Here is a table summarizing the characteristics of ETFs as compared to mutual funds:
Here is a table summarizing the characteristics of ETFs as compared to mutual funds:
EXCHANGE TRADED FUNDS (ETFs) VERSUS MUTUAL FUNDS
Happy New Year! We hope you had a wonderful holiday season and wish you prosperity, good friends, and good health for 2025 and beyond. We are pleased to report that the broad Morningstar index increased by 24.09% for the year and 2.57% in the fourth quarter. The "growth" segment of the market, particularly companies like Apple, Microsoft, NVIDIA, Amazon, Alphabet, Meta, and Tesla, has been a major contributor to this performance. Together, these seven companies are valued at approximately $17.92 trillion, which represents around 44.80% of the S&P 500. Their performance remains a significant driver of broader market trends. Several key events have recently influenced the financial landscape: The post-election “Trump Rally.” Bitcoin's significant rise, recently reaching around $100,000. Potential tariffs and their uncertain effects. Government debt interest payments surpassing defense spending, ~$1 trillion vs ~800 billion respectively. A notable increase in government employment in 2023, with 709,000 jobs added, a jump from 299,000 in 2022 and 392,000 in 2021 (source: www.bls.gov). The establishment of the Department of Government Efficiency (DOGE). The full impact of these events is still unfolding, but potential risks to market stability include tariffs, government debt, and the new DOGE department. While tariffs could have far-reaching effects, it is important to recognize that the policies discussed during campaigns may not align with actual implementation. Government debt may not pose an immediate concern, but over time, the bond market may react to the growing debt load, leading to necessary spending cuts. Though such measures could be painful in the short term, they may be necessary for long-term economic stability. The potential impact of the Department of Government Efficiency remains unclear. Elon Musk’s restructuring of Twitter (now X), which resulted in the elimination of thousands of jobs, has been seen as an effort to increase efficiency. Historically, the closure of government departments has been rare; the only significant example occurred during the Carter administration, when Alfred Kahn successfully dismantled the Civil Aeronautics Board (CAB), leading to lower airline prices and more travel options. Overall, we expect the companies we monitor and invest in to remain profitable. Despite potential disruptions, 2025 is likely to be another positive year for the market, though some volatility or "jolts" along the way should be anticipated. Enclosed is our annual privacy notice (mailed letters). Additionally, if you would like a copy of our ADV, it is available on our website or can be sent upon request. Lastly, I want to express my gratitude to Kathy, Nick, Keith, and Alison for their excellent work. Please feel free to contact us with any questions or concerns. We remain committed to providing the best financial advice to support your well-being. Sincerely, Willis Ashby, President Integra Financial, Inc. 5105 DTC Parkway, Suite 316 Greenwood Village, CO 80111 303-220-5525 / 303-689-0973 FAX Bureau of Labor Statics, Wall Street Journal, 1 st Trust, Morningstar, Zacks Research, Co-pilot &/or ChatGPT
I hope you had a wonderful summer and are enjoying weather similar to what we have in Colorado. The Morningstar broad index rose by 3.59% this quarter and is up 19.65% for the year. In a long-anticipated shift, value stocks—such as Costco, Comcast, and Home Depot—have outperformed growth stocks like Google and Amazon. The growth sector, which has led the market for so long, is now seeing stretched valuations and limits to growth, making the value side increasingly appealing for investment. As we focus more on value investing, it’s rewarding to maintain a diversified portfolio that includes both value and growth stocks. Reflecting on the past year and beyond, I’ve been reminded that “the market climbs a wall of worry.” It can be challenging to invest when headline news seems discouraging, but I’ve witnessed this pattern often enough to firmly believe that the best strategy is to enter the market and stay invested. Many of you who have been with us for a decade or more can attest to the benefits of this approach. Viewing investments through a long-term lens—thinking in decades rather than years—helps manage the inevitable market fluctuations. I don’t want to come across as overly optimistic, but there are positive signs: inflation is declining, incomes are rising, and personal savings rates are up. Gross Domestic Product (GDP) is also on the rise, with many corporations exceeding their earnings expectations. Historically, during periods of high inflation, like the Carter years, the stock market has proven to be an effective hedge against rising costs. As expenses—wages, goods, and taxes—increase, the value of stocks tends to follow suit, as corporations pass these costs onto consumers while striving to maintain their profit margins. Nick, Keith, Alison, and I are closely monitoring various factors that could impact the market and your portfolios. As always, we’re keeping an eye on the overall economy, particularly monthly employment numbers. Currently, over 60% of new jobs are in government or government-related sectors, which is less favorable than if the majority were in the private sector. The Federal Reserve has recently lowered the Fed Funds Rate by half a percent, a move prompted by falling inflation that appears to be trending toward the target rate of 2%. This reduction has been celebrated on Wall Street, as it lowers the cost of borrowing, benefiting both businesses and the government. Another trend we’re addressing is the stock-to-bond ratio in your portfolios. The stock side has grown much faster than bonds, for example, an initial 50/50 allocation is now closer to 60% stocks and 40% bonds. To rebalance your portfolio, we will sell some stocks and buy bonds to return to the desired ratio that best suits your investment strategy. In closing, I want to emphasize the importance of being vigilant with your online activities. The number of malicious actors attempting to hack personal information is increasing daily, so please take precautions. If you have any questions or if your financial situation changes, don’t hesitate to reach out. Alison, Keith, Nick, Kathy, and I appreciate your trust and are here to support you. Willis Willis Ashby, President Integra Financial, Inc. 5105 DTC Parkway, Suite 316 Greenwood Village, CO 80111 303-220-5525 / 303-689-0973 FAX
Salary-reduction-type retirement plans have, for some time, permitted so-called “hardship distributions” or “hardship withdrawals” prior to a participant’s retirement date. Salary-reduction-type plans include Section 401(k) plans available to for-profit employees, 403(b) plans for not-for-profit employees, and 457(b) plans for State and local government employees. Generally, such distributions are includible in a participant’s income and are subject to an “early distribution 10 percent penalty”, unless an exception applies.
Inheriting Traditional or Roth IRA Proceeds:
Some points to consider: 1) Likely the biggest distribution question that a 401(k) participant asks is: should I rollover the proceeds to an IRA or retain it within the 401(k), assuming the plan sponsor allows that? There is no certain answer to this question, although in the majority of situations, it is preferable to roll the proceeds because of participant control of the account. See Willis, Nick, or Keith to begin the paperwork for a Rollover IRA.
Greetings! We hope this letter finds you well. As you head into the heart of summer, we hope you're ready to make the most of the season. Whether you're planning a relaxing vacation, enjoying outdoor activities, or simply basking in the summer sun, we wish you a season filled with joy and memorable moments. Let's dive into the latest updates from the financial world.
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