Ep 4: Beginner's Guide to Mutual Funds & ETFs

Jessie: Welcome to Market MakeHer. An investing education podcast designed to help you navigate the stock market and achieve financial empowerment, from ‘her’ perspective. I'm Jessie DeNuit, here to ask all the questions, that a beginner, unfamiliar with the world of investing, would want to know.

Jess: I'm Jess Inskip, the resident financial expert, who gave up her financial licenses in order to provide free stock market education for all. Which if you're new here and found us from TikTok thank you for joining us on this journey today.

Jessie: And in this week's episode we are learning about mutual funds and ETFs. And our video theme for the day is flower crowns if you're watching on YouTube please feel free to tell us what our next theme should be. Jess, what is a mutual fund?

Jess: A mutual fund it is a basket full of securities. That is the most common analogy.

Jessie: So wait, but what is the security is that different from a stock?

Jess: A security can be a stock. It can be another mutual fund because you can have a fund of funds and we'll talk about that a little bit later. It can be a bond or fixed income product. Which we haven't gotten into. Those just are intended for income. It can also be cash. Securities are different types of investment asset classes. So, stocks, mutual funds.

Jessie: See I always thought Security in stock was interchangeable but it's not really it's

Jess: no

Jessie: A stock is a security. But a security is more than a stock. It's a stock, bond, cash, whatever we're investing with.

Jess: So what a mutual fund is. It's that basket or investment vehicle almost like a community fund. Everyone puts their money together. So, you have access to more diversification, which is more securities. So, a lot of stocks, a lot of bonds, a lot of cash, a combination, and then it's professionally managed by somebody. So, an expert, a money manager. And then the purpose of that fund is it generating returns for the investors.

Jessie: Okay so a mutual fund, is like a bag full of securities. Which is stocks, bonds, all these different assets we're talking about. But this is like actively managed by someone who knows what they're doing. They're the ones that have, like, picked all of the securities that go into this bag. They're the ones that are, like, removing some, adding things. Like switching it out based on what the mutual fund is that you picked?

Jess: If we had a group gift that we were going into for somebody and we put our money together, we could either buy a lot of little things, or we could buy one really big thing. But either way, we have more spending power, because we put it together.

Jessie: Okay, that makes sense. We're on a gift registry for someone for their baby shower or whatever, birthday, something going on. And yeah, we pool our money together to get, like, a really big, more useful gift. Like they want a stroller or crib versus like onesies or whatever.

Jess: You get more bang for your buck.

Jessie: So, what's the difference between a mutual fund and an ETF?

Jess: ETFs are a newer product. And it stands for exchange traded fund. That's where the difference is of fund is: a investment vehicle where people put their money together and a mutual fund, like it's literally in the name. It's a mutual fund because we mutually put our money together. Now, we have an exchange…

Jessie: I never even put that together mutual fund we're doing it all mutually together.

Jess: Exactly. And then exchange traded funds. Like, it's literally in the name as well. We now know what exchanges are. That's where stocks are listed and traded. And so the main, main, difference between an exchange traded fund and a mutual fund is that the exchange traded fund is traded on the secondary market. The mutual fund is not.

Jessie: When you say secondary market…

Jess: yes.

Jessie: Is there a difference? What is the secondary market?

Jess: That means it trades like a stock. Thank you for keeping me out of financial jargon land there.

Jessie: Then what's the first market?

Jess: IPO process.

Jessie: Oh. Okay.

Jess: So, a mutual fund is purchased in shares or dollars. And that's because they have a net asset value. So, it's the price that that fund is worth is determined at the end of the day. The exchange traded fund… you can buy it like a stock. So, it's a different type of order. Which means you can buy it in the morning, sell it five minutes later if you want. Whereas mutual funds only trade once a day. So, you could technically buy it today, and then sell it tomorrow. Not a good idea and there are fees with that we should talk about. But that's the main difference is the way that they're traded.

Jessie: So, technically you can only buy a mutual fund once a day or sell it once a day. So, you… you sell it once a day or you buy it once a day?

Jess: Both. All of the trades happen at one time, all together.

Jessie: All the trades within that one mutual fund?

Jess: It's just a value of those securities and they're closing prices at the end of the day, one time.

Jessie: Oh! I think I see what you're saying! Because when you buy an individual stock that, like, I could buy it at noon, and then at 4 pm the price could be completely different, right? But the mutual fund… you buy it that day and that price for that fund stays the same all day?

Jess: Yep! it has one price a day

Jessie: For a mutual fund. There are many different types of mutual funds. Same with ETFs, exchange, exchange traded funds, they both consist of multiple assets, right? The only difference between a mutual fund and an exchange traded fund is that the price of that fund stays the same all day. An ETF price can fluctuate. It fluctuates just like an individual stock would all day long.

Jess: And that's the main difference. Not the only difference. The main difference. We should get into active versus passive. So, we talked about the S&P 500. You cannot buy the S&P 500, but you can only buy a mirror of the S&P 500 and those mirrors are found in a mutual fund or an ETF. That is a type of passive investing. There are so many mutual funds and so many ETFs all that track the same index and try to match that Benchmark and that's where expense ratios come in. Basically, like the annual cost of the fund, the operating expenses. There is a cost because there's an active manager. So, you're getting this benefit of diversification because you're getting a bunch of assets put together. If it's a passive fund, the benchmark is that index and for that active management you pay an expense ratio an active fund that is where you've got your professionally managed money manager or portfolio manager of those funds, and the intent of that active fund manager is to beat that Benchmark. So, they need to beat the S&P 500 which means you're paying an expense ratio for someone to do better than their Benchmark.

Jessie: We're talking about how passive or active the managers within those funds are behaving and that's what drives the cost of the expense ratio?

Jess: But active means somebody's doing something more. So, I suppose it's the, the difference is, is you've got a personal stylist, who you're paying a fee for and they're going to go curate a wardrobe for you. And you're going to be amazed. They're going to do better than you ever could have done. Whereas, if you have something that's passive, you're just going to say: “okay I like what this person is wearing, just go get me that.”

Jessie: mmhhhmm

Jess: So, it's just a mirror and the other one's trying to outperform the other. And there's a higher fee for outperformance.

Jessie: Okay. All right.

Jess: we just talked about index funds though there are a lot of different funds.

Jessie: When you say Index Fund… those are in both mutual funds and ETFs?

Jess: That's right.

Jessie: So, the next fund is that. We're talking about S&P 500, because that's one of the indexes or indices that we learned yeah in episode two.

Jess: Yes. that's right. So, an index fund, the intent of it is to mirror exactly what it sees and match the performance of that index.

Jessie: okay

Jess: Very popular S&P 500 funds

Jessie: So, then what are the other types of mutual funds or ETFs?

Jess: So, you can have a stock fund. This is where there are a lot of variations of the stock fund so we can spend a lot of time on that. So, in the last episode, we talked about how many different stocks there are. Right? You've got your capitalization: So: small, medium, and large cap. You've got your stocks that are on the growth side or the value side. The in-between, which we did not talk about, is called blend. That's where you…

Jessie: We didn't talk about that. Yeah.

Jess: We did not. You're so you're not too small to be value but you're not so big that your growth. You can be a combination of any of that and that's a stock fund. So, you could be a large cap and growth you could be a large cap and blend.

Jessie: Yeah.

Jess: medium like it's just it's actually in this little um.. like a tic-tac-toe box wherever you fall it's called an equity style box. We'll put that in the episode equity for sure.

Jessie: Okay. Okay, so what are the other types?

Jess: So, we have a bond fund.

Jessie: Okay.

Jess: a bond

Jessie: Are we gonna talk about what a bond is?

Jess: For a very brief moment. When you have a stock, you own a piece of the company. When you have a bond, you own some debt from that company. It's another way that they can raise capital. So, Apple may issue what's called a corporate bond and they'll pay you some interest for that it's called a coupon. Just like a CD, it's got a maturity date attached to it. But it also gets some interest as well. So that that's what a bond is. So instead of owning…

Jessie: a bond isn’t just from the government. Like, I think for the longest time, I thought bonds were only from the gov like government bonds. Where you're like loaning the government money and they give it back to you with like a little bit of interest at a later date.

Jess: Nope there are so much fixed income products.

Jessie: So, a company can also issue a bond. And a bond is like, what? Like an IOU?

Jess: That's exactly right. It is an IOU.

Jessie: So, there are mutual funds and ETFs that comprise of both stocks and bonds or even just only bonds?

Jess: Yes.

Jessie: Okay.

Jess: So, that's called a balanced fund. So you can have stock funds just stocks you have bond funds that are just bonds you have a balanced fund which is a combination of stocks and bonds.

Jessie: okay.

Jess: and cash… which leads to our next one: money market funds. I'm calling it cash. But it invests inside the money market fund, because remember, it's a pool full of assets, a really short-term securities. so commercial paper is an investment that goes in there, short-term treasuries, things like that.

Jessie: This is a caveat, but just so everyone knows, when you do put your money into a money market account at a brokerage, when we get into that episode, do not leave it there. You still have to go take that and purchase your mutual funds, ETFs and stocks. Make sure that money is not just sitting in the money market account. You have to invest it.

Jess: Yes, you do.

Jessie: So mutual funds, ETFs, can also.. can be comprised of like individual stocks or indexes of stocks? like S&P 500 or different ones? they could also be comprised of bonds, money market accounts, anything else?

Jess: International or Global exposure funds.

Jessie: Okay.

Jess: and it all comes down to their investment objective. What's the goal of this fund ? What is the goal of this portfolio? We're getting in this vehicle, where is it going to take us? So may have international exposure. There's specialty funds. So those are the funds that are focused primarily on ESG. So that ethical investing. You can find funds that do that and then of course there are target date funds.

Jessie: The retirement ones.

Jess: So, they are a fund of funds. Which is probably the most confusing thing ever. So, a mutual fund is a lot of stocks bonds or cash or a mix of that. Right? A target date fund invests in mutual funds. So, now that we know bond funds and stock funds. Stocks are traditionally considered the more aggressive thing. The way that that stock will go up in value, is if that company makes more money. If you have a bond, they owe you money. If they go under, creditors are paid first. And you're a creditor there. So, if something happens to that company, you're first on the payout list. So that's also another reason why they're…

Jessie: oh

Jess: …considered less risky. But they also have grades and stuff. So, without going into much detail, if you invest in a target date fund, you specify. You say: “okay, I'm going to retire in 2065.” And it will start super aggressive, so more stocks, and it's always a combination of stocks bonds and cash, with a bunch of mutual funds. And it will start rebalancing itself over time. And take it from more aggressive to less aggressive. It's going to take the stock position away and slowly give you more income. Get you to cash at some point. Those actually have the highest expense ratios. Because if you think about it, every mutual fund has an, its expense ratio. Now you have a mutual fund made up of mutual funds. Now you have a ton of expense ratios. And then that mutual fund has an expense ratio. Also, fun little fact, how you tell if something is a mutual fund, and there's actually this whole methodology to stock symbols or tickers, they like to be called. I know that something is a mutual fund because it has five letters, and it ends in an X. Always.

Jessie: Oh! Okay.

Jess: every single time.

Jessie: Did not know that. So, they're always letters?

Jess: Always letters. Yes.

Jessie: Okay. Five letters. Ends with an X, that's a mutual fund. Brilliant. Taking that away…

Jess: yes

Jessie: today.

Jess: Now. Here's the main difference: if you have an ETF, what you're purchasing is the share price. They act like a stock. It's accessible because there's a secondary market. When you have a secondary Market means we can buy and sell easily right. A mutual fund you buy in dollar amount, or you can in share amounts. But they sometimes have minimum investments. You may not be allowed to buy into that fund unless you have five hundred dollars or twenty-five hundred dollars. So, there is a minimum amount that you can invest. They also have minimum holding periods, where you can't sell that mutual fund for 90 days after buying it. And if you do, you'll get something called a short-term redemption fee.

Jessie: When you buy a mutual fund that has at least like say 90 days before you can sell it… it says that on there? or do you have to read that prospectus thing to even find that out?

Jess: It's in the prospectus. But it's normally right in front of you when you purchase the mutual fund. Your brokerage firm is required to tell you all these fees and things.

Jessie: Okay. Okay, so short-term redemption fees should be laid out right there when you're trying to buy the mutual fund. And that's just telling you like you have to hold this mutual fund for this that amount of time before your you can sell it, or you'll occur additional fees?

Jess: Yep. You'll get penalized. Kind of like if you were to invest in a CD. You're required to have that for a certain period. And if you don't hold it for that certain period, you're going to get penalized. That's what happens.

Jessie: But ETFs don't normally do that?

Jess: Nope. They don't. Because you can buy and sell them on the market. so that's the difference. So, one is definitely intended to be long term which is a mutual fund.

Jessie: Okay.

Jess: Whereas if you want access to those funds. But wait! there's more! There's so many fees with mutual funds. You have what's called a front-load fee that means that when you first buy into the fund you have to pay a percentage of what you purchased. Or they have a back-end load where when you sell, you have a percentage of when you sell. The reason why they will penalize you, if you sell early and have minimums, if you are selling out of that fund, they have to make adjustments within that fund, they're gonna have to start selling securities and then buying more. do so. And that can hurt the other investors. And so that's why they charge you a fee… is they really want to discourage you from selling, buying and selling in and out of that. But those fees, they're not black and white, it's not like oh this mutual fund has this fee and that's consistent it actually varies by your brokerage firm. Because there are agreements that they have.

Jessie: Okay, I didn't realize all that. That makes sense though.

Jess: But it's mainly for active remember if you have an active mutual fund, you want someone to beat the S&P 500 or their benchmark. Whatever that may be.

Jessie: What do you mean by by saying beating the stock market?

Jess: great question. If the S&P 500 is up by 10% in a year then, if you, your portfolio was up 11% that year… you beat the stock market by one percent.

Jessie: Oh! Okay. Is that supposed to be one of our goals? We should always be looking to beat the stock market in our portfolios?

Jess: Not necessarily. We want to be in line and we want to grow our wealth. And I totally believe in having an investment thesis and buying some stocks you believe in. Absolutely we can have a fun term out there. I love this term, I love the Greeks, if you know me personally.

Jessie: I’ve heard you say that a lot and I'm like I don't understand what any of that means.

Jess: It's all just measurements. So, there's something that we use on the stock market called beta. The S&P 500 has a beta of one. And mutual funds can be assigned to beta or ETFs assigned a beta, stocks are even assigned to beta. And what that means is, if a stock or a fund, like Tesla is a really great example, I don't know the beta off the top of my head, but it's probably four… Means that it moves four times more than the market. It's more volatile. It's an emotional stock.

Jessie: Like up and down?

Jess: Yes, it just moves like crazy. It has temper tantrums. The market has a beta of one. Like it's literally off of the S&P 500. If a stock has a beta higher than one, then that means it moves more than the market. If it has a beta less than one, then it moves less than the market. And that's important if you're an emotional investor. If you can't…

Jessie: You’re not supposed to be an emotional investor, right?

Jess: You're not. But some people are. And if you cannot handle the volatility of the market and maybe you just want to have an income producing portfolio, you need a lower beta. T

Jessie: That's a different strategy then?

Jess: A completely different strategy. It all will come together. We can't explain it all in one episode. We're literally setting the table. You're going to understand what the stock market is, what a stock is, what a mutual fund is, what an ETF is… the difference of them. The ins and out. We'll talk about brokerage accounts features that are there. Then we'll get into the really good stuff. I mean it's all great. But.

Jessie: yeah

Jess: It's… you have to know this before you can do that.

Jessie: Okay good. I only have one like final question. And I think we touched on it but I just want to make sure we understand or start to understand. How do you get your money back that you invested for mutual funds or ETFs?

Jess: Mutual funds don't have as much transparency as what's inside their portfolio, they're required to report that once a quarter. And so, you have more visibility into those ETFs. So, you have the objective of both. You know their intent, their goal. but they make funds…

Jessie: The portfolio is the basket, or the bag, or the vehicle?

Jess: Yes.

Jessie: When you say portfolio. Okay. A mutual fund has a portfolio. An ETF has a portfolio. and then we as investors also have our own portfolio that's comprised of all the things we've bought right?

Jess: Yeah, exactly. You have a bunch of baskets. You've got eggs in that basket and then those eggs may have jellybeans in it. You know like in Easter… and then maybe we found that..

Jessie: Easter Egg Hunt! Like my family's place. We have all these little booze and scratch off tickets.

Jess: And maybe you have that. That's a great analogy though. So, you literally. Your basket is your portfolio. It's an Easter egg basket. You put eggs in that basket. Like there was always the golden egg you know. If you find the twenty-dollars or five-dollars and as a kid you're like, I’m rich! But that's that's like picking a good stock. So great analogy. But anyways, so you get your funds back in some way. So you want to cash in your Easter egg basket here's how you can do that: First and foremost is dividends. If that mutual fund has stocks that bear dividends, if they have a bond, that I owe you, that loan they're going to give you that income in the form of what's called a distribution. When they give you that distribution, it can be monthly it can be quarterly it's their schedule just like the stock has a dividend schedule. And when you get those dividends, or that distribution back, you can say: “I actually want to reinvest that back into the mutual fund, thank you.” Or you can receive it in a part of cash.

Jessie: So, what you're talking about... we haven't sold it yet.

Jess: We have not sold it.

Jessie: Do you have to say: “I want to reinvest those dividends”? Like, where do those dividends go? in your money market account?

Jess: Comes in the form of a distribution. If you choose to have have it in cash, it'll go into your money market fund or the default cash position that's found in your brokerage account. If you choose to have it reinvested, it will buy more shares of that mutual fund.

Jessie: ETFs don't have dividends?

Jess: They do have dividends. But they don't distribute them in the same type of way. Acts more of the way that the stock gives you the dividend.

Jessie: What else we need to know about selling a mutual fund or getting money back out of a mutual fund?

Jess: They also have capital gains and their quarterly rebalancing act where they make sure that everything is in line with that investment objective or that goal. They may realize what's called a capital gain which means they sold something that they bought at a lower price and then they also give that to you in the form of a distribution.

Jessie: oh, like when you sell a house.

Jess: and they're actually required to give you those capital gains at least once annually. So normally it's at the end of the year.

Jessie: Wait. So, me as the pur… investor, purchaser, I can get both dividends and I can get capital gains?

Jess: We still talked about two of three though.

Jessie: More ways I can make money.

Jess: Yes. And then number three is just like the stock. It increases in value and you just sell it at a higher price.

Jessie: The whole fund?

Jess: The whole fund. And the main difference is with the the third one that's an action you take. You say I am done with this fund I would like to sell it. The first and the second as long as you hold it during their requirement periods you're gonna get those distributions that are in the form of income or a capital gain and they're taxed.

Jessie: So that's why you would buy a mutual fund.

Jess: Why you would buy one is you can buy a lot of stocks. So if the investment objective of that mutual fund or ETF was income, then you would buy a lot of stocks that have a dividend and then they would manage that. So, it just offers you diversification and that's part of strategy and in right is making sure that you have appropriate risk allocation and part of that is not being concentrated in one thing. That term you don't have all your eggs in one basket.

Jessie: Don't have all the same eggs in one basket.

Jess: Yeah.

Jessie: I'm starting to understand how you make money off of them. I guess strategy is when you know when to sell.

Jess: It is. the purpose of today's episode is just to understand the differences between mutual funds and ETFs. They're not as basic as what has been outlined to you.

Jessie: Right.

Jess: It's not just an S&P 500 fund. There are so much more out there that could…

Jessie: So many different things.

Jess: So many things. If you are looking for something passive, we need to look at expense ratios and a mutual fund, all of the other expenses that come along with it. Which are those front-end load, backend loads, short-term redemption fees. They're there for a reason because they're constructed very differently.

Jessie: okay and we did have an Instagram question. Let's go ahead and ask it. It's from Stephen and it's: what's the benefit of purchasing the ETF versus just the underlying stocks on your own?

Jess: Thank you, Stephen, for the… the wonderful question. So the benefit of purchasing the ETF is you can put a lot less dollars into the same type of exposure. So, it's very expensive for you to buy a lot of stocks. Right now there aren't any transaction fees when you buy. There are some SEC fees when you sell. But when you buy, there aren't any commissions. However, it takes a lot of time to buy a lot of securities. Whereas it takes so much less time to buy one security that offers you the same type of exposure.

Jessie: Which is an ETF.

Jess: So, it's really leverage. You can put less money to work. It doesn't cost as much, so it takes down a barrier to entry. It trades like a stock, so you can get out of it if you want to. The main main difference… you have no voting rights at this point. You own a fund that owns the stock. You don't own a piece of the company; you own the fund.

Jessie: Okay. I think we can stop there for today. And let our brains marinate on all of that great information. And please feel free to message us any like further questions you have and what we talked about today you can do so on our website www.marketmakeher H-E-R podcast.com and I'm finally getting around to writing the content to share my Jessie's notes that I've been talking about on other episodes. Go ahead and subscribe to our email list as well if you would like to be alerted.

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Jessie: And it also appeases the algorithm gods and goddesses as you all know very well. So, anytime you comment, like, share, subscribe, save. It definitely helps us continue to provide free education for everyone.

Jess: Absolutely

Jessie: I think that's the wrap for today. So, until next time. Keep investing, keep learning, and keep breaking those barriers.

[disclosures]

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