The More You Know | WSBE 421

ETFs and mutual funds are similar methods of buying into a pool of securities. But there are several major differences between the two investments. The two biggest: 1) ETFs trade like stocks–all day long. Mutual funds are traded at the end of the market closing day. And 2) mutual funds include several Costs & Expenses that ETFs do not.

Loads: Some funds charge front-end loads, ranging from 3.75%-5.75% of the monies you initially invest. Note that funds may also charge a front-end load for reinvesting your dividends back into the fund.

Back-end loads may range from 4-5.75% of the funds you redeem or cash out, in the first year of ownership, but then may subsequently decline until they reach zero, in about the sixth year.

Some funds do not have front- or back-end loads, and are called No-load funds.

Expense ratios: These expenses are the cost of doing business, and include administrative and management fees. They are calculated as a percentage of net assets managed. And while they have been declining (mostly due to the proliferation of less expensive ETFs), the current average for actively-managed funds is 0.5%-1.0%, but may go as high as 2.5%.

12b-1 fees: These fees are marketing and distribution expenses. They are included in the fund’s expense ratio, but often separated out as a point of comparison. They are charged in addition to loads, and even no-load funds may have them.

Taxes: When a fund manager sells a stock from the fund at a profit, the gain is taxable. Short-term gains (for investments held less than one year) are taxed higher, at your individual income tax rate, while long-term gains (for investments held more than one year) are currently taxed at an approximate 15%-20% rate, depending on your income. Many investors tend to forget about taxes on funds since they aren’t privy to the fund manager’s everyday buying and selling of investments and the losses and gains accrued, and are often surprised by the tax bite at the end of the year. Consequently, it would be wise to pay attention to the next important item on our list…

Turnover. This refers to the frequency of trading undertaken by the fund manager. The more buying and selling he does, the higher the turnover, and the greater the potential tax bite. This is another area in which index funds are advantageous, as their managers generally trade less than actively-managed funds, so they usually accrue lower tax bills.

The next Wall Street’s Best ETFs issue will be published on May 4, 2021.

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