Investors increasingly are using exchange-traded funds (ETFs) in place of — or in addition to — "traditional" mutual funds.
SMI executive editor Mark Biller offered a quick primer on ETFs yesterday on Moody Radio's MoneyWise Live, and he explained how and why we use them in certain SMI strategies.
Mark also talked briefly about A Road Map to Retirement Plans for Small-Business Owners, an article in our July newsletter. He then took caller questions, including one about the pros and cons of rolling over a 401(k) into an IRA.
To listen, click the play button below — or, if you prefer, scroll down for a transcript. (And for more radio appearances by members of the SMI team, visit our Resources page.)
MoneyWise Live, hosted by Rob West and Steve Moore, airs daily at 4:00 p.m. ET/3:00 CT.
To ask a question on a future program, call 1-800-525-7000 and mention you have a question for either Mark Biller or Matt Bell of Sound Mind Investing.
Rob West: Mark, so glad to have you back with us today. Thanks for being here.
Mark Biller: Thanks, Rob. Good to be here.
Steve Moore: Well, why don't you help us unpack this event as we explore ETFs for our listeners. Why don't we start with a quick definition.
Mark Biller: Sure. Well, first of all, ETF is short for Exchange Traded Fund and an ETF is a marketable security or an investment that tracks an index, a commodity or a basket of assets like an index fund. Now the ETF is gonna own the underlying asset. So it's gonna own the shares of stock or the bonds, the gold bars, whatever it's tracking, and then it's gonna divide the ownership of those assets into shares that you can buy and sell. So, in that way, ETFs are very similar to index tracking, mutual funds, which are also a basket of investments, stocks, bonds and so forth. So the main difference between traditional mutual funds and ETFs is the way that they're traded.
Steve Moore: So, Rob, do they replace other mutual funds or index funds?
Rob West: Yeah, I would say they're most often a replacement for index funds but not always for mutual funds. Keep in mind many folks who invest in mutual funds are investing based on the fund manager and the specific market sector or investment strategy outlined in the prospectus. These investors are looking to out perform the market index through the unique skill and expertise of the fund manager like our very own Mark Biller on today. And in this way, an ETF would not be a replacement since ETFs run by professional money managers are still fairly scarce in the industry.
Steve Moore: Mark, do you use these or recommend these at SMI?
Mark Biller: Yeah, we do in a couple of different ways. We have some strategies where we use ETFs to get exposure to whole asset classes. So, for example, we'd use one ETF for U.S. stocks, another for real estate and so on. And then we've got other strategies where we combine ETFs along with traditional mutual funds and use a blend of both fund types to fill out a portfolio.
Steve Moore: Oh, okay. Rob, any other advantages that you like?
Rob West: Well, one of the main advantages is the expense ratios for most ETFs are lower than those of the average mutual fund. That said, you'll have to pay the same commission to your broker or custodian that you'd pay on any regular stock order. There exists potential for favorable taxation on cash flow, Steve, generated by the ETF since capital gains from sales inside the fund are not passed through to the shareholders as they commonly are with mutual funds.
Steve Moore: Okay, and are they traded the same way?
Rob West: Unlike mutual funds, an ETF trades like a common stock on a stock exchange so, the ETF's experience price changes throughout the day as they're bought and sold. They typically have a higher daily liquidity and lower fee than mutual fund shares, making them attractive for individual investors because they're not gonna trade like net asset value on a mutual fund, it trades more like a stock.
Steve Moore: Really great to have you with us today on MoneyWise Live. Also with us today, in the guest chair, is Mark Biller. Mark's the executive editor of the Sound Mind Investing newsletter. He also manages the SMI mutual funds. And in his spare time — I understand, I've read this — is a spelunker, likes to hang out in caves. Are you that guy, Mark?
Mark Biller: Oh, no. No. (chuckles)
Rob West: I don't know where he gets this stuff, Mark. I'm sorry.
Mark Biller: I know.
Steve Moore: I'll shift gears and ask you — going back to our original topic here, ETFs — are these, because I know you reach out to all sorts of people at SMI, are these for the active or the passive investor? The new investor or the real sophisticated guy?
Mark Biller: Yeah, really, they can be both, Steve, you know, ETFs, I think, are most commonly used in a passive investment approach like an indexing type of approach and that's a real easy path for newer investors. But, like I was saying with some of our strategies, we use them in a more active management setting. So, they really can go either way.
Rob West: You know, Mark, as you think about ETFs versus mutual funds, there would be those out there that just say, "Don't even bother trying to beat the market. Let's just mirror the market and kind of follow the market up and down" — in the broad market, I'm speaking of. Versus those that say, "No, there's a particular skill or expertise of a professional money manager and I really wanna use a mutual fund to tap into that. There's not a right or wrong approach, so how do you begin to process that decision to determine what's best for you?
Mark Biller: Yeah, I think one of the big things, Rob, is, one, do you have an active approach that you have confidence in 'cause most people, you know, if they're coming up with it themselves, they're not gonna have a good chance of beating the market and those folks should be using a passive index fund approach. But if you have a strategy like, you know, our strategies that we put in our newsletter, of course, we think they're gonna do well. If you click with one of those or somebody else's and think you've got a chance to beat the market, then you might be willing to do that. But, you usually have to be wiling to put in a little more effort too. You can't always just sit back and expect to get those better than average results.
Rob West: Mark, before we start taking some phone calls here today, I know a new article that you all just came out with is called the A Roadmap to Retirement Plans for Small Business Owners. This is, obviously, an area for small business owners. They don't have an HR department that's already selected a plan where they can just tap into it. They're having to make a lot of these decisions themselves and often don't know what's available. Now, give us some of the highlights of what's here.
Mark Biller: Yeah, I think the key there, you know, if you're a small business owner, you'll definitely wanna look at that article and get the particulars, but even for those who maybe are not small business owners, which is most of us, the principles in that article apply, really, to most of us, because it breaks down along two tracks. On the one side, you've got these qualified plans which, that's just a fancy word for "heavily government-regulated plans," like a 401k that you might have at work. And then the other track is the IRA track. If you don't have that or maybe in addition to your company plan, you can invest through an IRA for your retirement.
And small business owners have similar choices. There's some specific things that are available to them that are on one side of that fence or the other. They're either based on IRA investments or they're based on a more heavily regulative plan like a 401(k). So if that's something that's of interest to listeners, if you're a small business owner, you can read that article. It's free on our website at soundmindinvesting.org and can get into those details there.
Rob West: All right, Steve, I know we have a number of folks holding, I'd love to get Mark in the mix, here, today with some callers.
Steve Moore: Yeah, let's do it. Again, the phone number 800-525-7000. We begin by going to Zephyr Hills, Florida — WKES, great bunch of folks there, working hard every day — and Tammy, how can we help you? What's your question today for Rob West and Mark Biller?
Tammy: Hi, gentlemen. I'm just calling to find out — I have a 401(k) that I had with a company I'm no longer with. And I also have an IRA and I don't know if I should roll it over to the IRA or if I should let it stay where it's at or if I should — I don't know if I can even roll it over and would I roll it over into another IRA or what would you suggest?
Rob West: Yeah, Mark, a classic question. We get this one often. You know, Tammy's faced with this decision that so many are when they separate from a com pany. They've got this 401(k) sitting there, perhaps it's doing well, maybe it's not. What are the considerations, you think, they need to process as they think about, perhaps, rolling it out?
Mark Biller: Yeah. Well, generally speaking, Tammy, we're usually fans of rolling the 401k over into an IRA and the main reason for that is just the flexibility that it gives you in terms of how you invest that. Now that said, if you are planning to invest the money in the 401(k), pretty much the same way that it's invested now within the 401(k), there may not really be any pressing reason to move it.
But if, as is often the case, if you're limited in your investment choices within the 401(k) and you'd like to have more flexibility in how you invest that money, then the rollover into an IRA's usually a good move and that's why we usually recommend that for our readers because most of our readers would like to get outside of the relatively short list of investment choices they have within their 401(k).
And as far as whether to put it into the same IRA, generally, that is a convenient option because it consolidates everything in one place so, if you have that option, usually, most people prefer that. Rob, any extra thoughts on that?
Rob West: No. I think you're exactly right. Open up the investment universe, reduce fees, take control of the money and really, you know, that's typically going to be your best bet. You even open up the opportunity to convert a portion of it or all of it to a Roth IRA, as well. So, I like that counsel.
Steve Moore: Tammy, thanks for your call today. Another one, Dyer, Indiana. Jennifer, what's on your mind?
Jennifer: Hi. Thank you for taking my call. Can you hear me?
Steve Moore: Yes, ma'am, go right ahead.
Jennifer: I was at a former employer and they notified me that they are gonna be terminating their pension plan so they gave me a letter, a notice of plan benefits with way too many choices, of course. And I — anywhere from life annuities to certain, you know, like a 10-year secured annuity, you know, partial lump sum or lump sum payment. I just was wondering, what would be your general — is there like a general, like, this is the way to always go. You know, obviously, I'm way far away from retirement. So, it's not like I'll be retiring any time soon.
Steve Moore: Yeah, Jen, appreciate your question today. Mark, we hear this more and more where these pension plans are a way of the past and often folks are presented with a multitude of decisions but taking the lump sum versus the lifetime payout, what are some of the decision points there that you encourage folks to look at?
Mark Biller: Yeah, one of the big things there is your comfort with making those investment decisions yourself. Because if you're taking that lump sum of course you don't wanna just take it and spend it. You're going to become responsible for how that money is invested. So really when you think about the annuity options the big advantages there are that someone else is investing that money for you so you don't have those decisions and presumably they're investing it in a relatively conservative safe way for you. Now, you can't always take that for granted but that's certainly the hope.
Now, when you take the lump sum, again, you're gonna become responsible for that. Now, if you're the type of person that is confident in your investing ability or you are working with an advisor that you have confidence in, that can actually be an opportunity, potentially, to try to earn better investment returns than you might get with the annuity options, which tend to be, like I said, invested conservatively, which is gonna mean, generally, a little bit lower returns.
With so much complexity around the different options, this is definitely an area where talking to somebody, an advisor, with expertise, is probably well worth it, even if you're not gonna work with that person on a long term basis, perhaps you can find a fee only advisor or somebody that can give you good counsel in sorting through those options.
Rob West: Yeah, do you wanna transfer the risk to the insurance company, in this case, or do you wanna take it on yourself and yet get more flexibility? Also, what is the equivalent rate of return on that lifetime payout? All considerations you're going to want to look at and absolutely an investment professional or a financial planner who is paid by the hour can help you process this decision, would be well worth the expense.
Steve Moore: And, Jen, if you don't have anybody like that in your life, and you're not sure where to turn, you can always visit kingdomadvisors.org and find someone in your area. I know we have a number of people in Indiana and, perhaps, that might help you. You're listening to MoneyWise Live with Rob West, and our guest today is Mark Biller. We'll be right back.
Steve Moore: Hattiesburg, Mississippi, WMFT — and Fran, how can we help you?
Fran: Yes, the money managers of our work portfolio of approximately $300,000, is charging a 1% of the portfolio value annually. Is this a fair charge?
Rob West: Yeah, Fran, I'm gonna ask Mark to weigh in on this. Let me ask you how have you done since you've been with these money managers?
Fran: Well, we have ... We've been with them for approximately six months.
Rob West: Oh, okay, so not a lot of time.
Fran: And that's what they said and I just wasn't sure if that was-
Rob West: What do you think about that Mark?
Mark Biller: Yeah, that is a very middle of the road type of fee for an advisor to charge of a portfolio that size. You're typically going to see fees in that 1% range. Some a little higher, maybe some a little lower. Typically, you're not gonna get into lower fees unless you have a larger portfolio or, perhaps, they're doing very, very simple investing for you. But 1% on that size portfolio is very reasonable, in my opinion.
Rob West: Yeah, I would completely agree, Fran, I think that's perfectly appropriate for the value of the portfolio that you have. The key is you wanna make sure you're getting proper communication, that you feel comfortable with not only how it's being managed but how they're really communicating with you about that and making sure that you're reevaluating on some periodic basis as your situation changes, that they have the way to get to know you over time. But in terms of the straight management fee, that would be perfectly appropriate.
Steve Moore: As a new client, how often would you expect this company to reach out to her or are they waiting for her to reach out to them?
Rob West: Well, I would hope that that would've been covered in the initial meetings as they get to know the client and the question simply is, how do you want us to communicate with you? Do you wanna sit down quarterly? Would you rather do it twice a year? Would you rather meet over a video conference? Do you wanna come into the office? And I would hope all that would've been worked out so that the advisor is meeting the needs and the communication preferences of the client.
Steve Moore: Okay. Fran, we're glad you called today and I think you can relax, at least, at this point in time, with that 1% number. Thanks so much. And again, we're discussing investing today, not only with our host but also with our guest Mark Biller of Sound Mind Investing.
Rob West: Well, Mark, we appreciate, so much, you being with us today. Always great to catch up with you. I know folks can check out this resource, A Roadmap to Retirement Plans for Small Business-Owners, on your website at soundmindinvesting.org — as well as search for information on ETF. So, thanks for being here.
Mark Biller: Thanks, Rob.
Steve Moore: This is MoneyWise Live.