Why does anybody still recommend or own mutual funds?
Ric Edelman: It's Tuesday, January 31st. Guess what? ETFs have now hit their 30th anniversary.
The first exchange traded fund was the Spyder S&P 500 ETF Trust, and for the first time ever, investors could buy and sell the 500 stocks of the S&P 500 in a single trade. Today, that ETF has $370 billion in assets. It's still the largest ETF in the world. ETFs have become the most popular investment vehicle in the country. There are now nearly 2000 ETFs on the market from hundreds of fund companies. ETFs are now far more popular than mutual funds, which have been around for 100 years. Mutual funds were created back in an era when Wall Street did business with pen and paper.
But ETFs, these things were built on computer technology. See, with a mutual fund, there's only one price per day. If you buy shares of a mutual fund today, you don't know until the end of the day, after the market closes at 4:00 pm what price it is you got - even if you put in your order at 10 a.m. And you don't even know what stocks the mutual fund owns because these funds only produce a list of their holdings twice a year. By the time you get the annual or the semiannual report, it's way out of date. Mutual funds are also very expensive. The average cost is 50 basis points a year. That's one half of 1% per year.
And mutual funds tend to flip their portfolios pretty often. They do a lot of buying and selling of the securities in their portfolio. And that triggers a lot of taxes. The average stock mutual fund in 2022 paid out a 7% capital gain, which means they distributed to their investors 7% of the value of the account, forcing you to pay taxes on that money, whether you wanted to or not, whether you were expecting to or not.
ETFs, by contrast, are superior to mutual funds in every way. When you buy an ETF, you get the price. As of that very moment, you know exactly the price you're getting. And ETFs disclose their holdings all the time. In real time, you never have to wonder what it is you're investing in. ETFs are also far cheaper than mutual funds. Instead of paying an average of 0.5% per year, the average ETF costs only 0.16% per year. That's two thirds less.
And ETFs are also very tax efficient. Of the nearly 2000 ETFs that exist, only 41 of them paid out any capital gain last year at all, according to Morningstar. No wonder ETFs are so popular. Investors added $600 billion to ETFs last year. At the same time, they withdrew $1 trillion from mutual funds. Clearly, everybody likes ETFs more than mutual funds, investors and investment advisors alike.
But here's the crazy thing. ETFs hold about $6.5 trillion in assets. Mutual funds hold $16 trillion in assets, $10 trillion more. Why, if everybody likes ETFs more and if we had net inflows of $600 billion to ETFs and net outflows of $1 trillion from mutual funds, why is it that there's $10 trillion more in mutual funds?
Two reasons. First, inertia. You bought your mutual fund 10 or 20 years ago and you're just not paying attention. You haven't gone to the trouble of improving your portfolio. And don't tell me you're not selling your mutual funds and moving to ETFs because of taxes, because two thirds of all the money in mutual funds are in IRAs and 401Ks; there are no taxes if you move the money. And even if you're in a taxable account, you're going to sell those funds eventually anyway. Unless you're going to die holding them. So you're going to pay the taxes eventually anyway. And the longer you keep your mutual funds, the more you're spending in fees every year, the more you're paying in taxes every year. So get off your butt. Replace your mutual funds with ETFs.
There's another reason, though, you might still be holding on to your old, antiquated, out-of-date mutual funds. It's because you bought them from a commission-based broker, and that broker, that advisor is getting paid as much as 1% per year for you to keep holding on to your mutual fund. If you're working with a financial advisor who hasn't recommended that you get rid of your expensive mutual funds, then you need a new financial advisor.
And if you are a financial advisor, you need to ask people you meet if they own mutual funds. They might not realize how much better ETFs are, and you can do them a lot of good and you can add a new client to your practice in the process by helping them understand the benefits of ETFs. And now you know why I talk about the ETFs of Global X, Invesco and Schwab on this podcast - and not anybody's mutual funds. ETFs have just celebrated their 30th birthday. It's time you join the party.
Gotta run. Today, I'm doing a private consulting gig for the board and investment team of a healthcare foundation. They want to understand crypto as an investment thesis for their endowment. I'm getting an increasing number of these requests. Everybody's discovering there's not a lot of objective independent educators in the field of crypto, and so I'm happy to provide these services to companies and organizations that are trying to learn more about this space. Anyway, that's what I'm doing today. So I'll see you tomorrow. Be sure to follow me on Twitter, Facebook, LinkedIn and Instagram.