In this week’s episode of Retire in Texas, Darryl Lyons, CEO and Co-Founder of PAX Financial Group, takes a closer look at two often misunderstood investing vehicles: mutual funds and exchange traded funds (ETFs). Building on last week’s discussion about stocks and bonds, Darryl breaks down the key differences between these two types of funds, how they operate, and what investors need to know when deciding between them.
Through real-world examples, historical context, and practical insight, Darryl explains why the evolution from mutual funds to ETFs has reshaped modern investing – and why understanding the nuances between them could be critical for your financial future.
Key highlights of the episode include:
• The origin of mutual funds, their human-driven decision-making, and the potential risks of overconcentration.
• Why exchange traded funds (ETFs) offer lower costs, greater accessibility, and often outperform traditional mutual funds.
• The behavioral traps of ETFs – including the temptation to panic-sell – and why discipline is key.
• The truth about 401(k)s, IRAs, and how they simply serve as “wrappers” for your actual investments.
• When actively managed mutual funds may still outperform passive index funds – and where an advisor can add real value.
Whether you’re debating between mutual funds and ETFs or simply want a better grasp of where your money is invested, this episode provides a thoughtful, accessible guide to making smarter investment choices – with an eye always on the bigger picture.
For more insights or to connect with a PAX Financial Group advisor, visit http://www.PAXFinancialGroup.com.
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Transcript:
Hey, this is Darryl Lyons, CEO and Co-Founder of PAX Financial Group. And you’re listening to Retire in Texas. This information is general in nature. It’s not intended to provide specific investment, tax, or legal advice. Visit PAXFinancialGroup.com for more information. So, last show I talked about stocks and bonds and the differences. And in this show, this may seem very remedial to you, but I think it’s important that you reflect on the stocks-bonds thing, make sure that there’s no misconceptions on how those things behave in a client’s portfolio.
I’m more inclined to own stocks because I think owning companies is a good idea, to have ownership in a company, whether you’re a small business owner or if you’re not a small business owner, to be able to access the markets, and access to be an owner of a company is to me absolutely amazing. And I’ve had to reflect on this a lot over the years, because I just think this idea of being able to participate in ownership of companies is absolutely, 100% understated, because think about it, if it’s 100 years ago, 200 years ago, maybe even a thousand years ago, to make it real, my family might have been a serf, or a peasant.
How are you going to get out of this thing? Like I’m not going to, in that situation, if I were that, I can’t go out and just go buy land to get rich or, you know, not likely going to marry rich. So, what happens to these serfs and peasants? Over the years, they just, that’s who they become the rest of their lives. And so, there’s a lot of ways to break through that in America. And one way that’s often discounted is by being able to own companies through the stock market, through the capital markets. It’s absolutely like, we are really, I wish I could sit down with you kneecap to kneecap on a couch and just explain how powerful this is.
But so, in the last podcast, I just shared that dynamic with you, and made sure that you understood how stocks work relative to bonds. This one is like 2.0, because I really want to make sure you understand how mutual funds work relative to exchange traded funds. And this is important because sometimes just a slight misunderstanding here can really throw off your game plan.
Making assumptions. And I tell you, I’m the worst. I am absolutely the worst. Where I assume somebody knows something that they don’t, I am, I promise you, I just do this all the time. And I’ve really worked on this. And so, the last podcast is just, you know, breaking down those assumptions and making sure that you clearly know the difference between a stock and a bond and how they behave.
This one I want to talk about the difference between mutual funds and exchange traded funds, which there are misconceptions here as well. So, what’s a mutual fund? So, a mutual fund is a mutually funded account with thousands of people across the country where there’s a manager, let’s say, in New York with a suit and a bunch of computers, and he’s responsible.
And I’m saying he, is responsible for buying and selling stocks on your behalf and all these other people around the country. That’s a traditional mutual fund. They started in 1924, so they’ve been around for a while. Good track record. And they allow people to not just own one company, not just own Microsoft or AT&T or Disney. If you’ve looked at Disney’s performance for the last five years or so, you’d be disappointed.
You wouldn’t have really met your objectives. But if you were to put your money in a mutual fund where it’s spread out, maybe you own some Nvidia or something. Collectively, you’re going to be okay. You know what it’s like, I guess, you think about Enron, like you don’t just own Enron. Imagine if you just put all your chips on Enron.
And I know, by the way, I’ve known people over the years that just bet on their company just because they had a probable cause, an expectation that was just rooted in facts. But they didn’t. They were missing some pieces of information that they didn’t know, and they lost it all.
I’ve seen that before, betting it all on one company. I’ve seen that over my career since 1999. I love owning stocks. I think owning pieces of companies are awesome. The mutual fund in 1924, when that came out, changed the game because now we’re not betting on all one company. Spread it out between I’ve seen, I guess I’ve seen as low as maybe 20 stocks in a mutual fund.
That’s probably about right to, I’m guessing maybe 2000, that may be on the high side. I’ve seen thousands of mutual funds and there are thousands. And in 1924, there weren’t that many. And over the years, because it’s become such a big business that there are a lot more again, mutual funds were great. We’re going to talk about how they differ from exchange traded funds, but just some of the other features of mutual funds.
Again, you mutually fund an account with thousands of people across the country, a guy in New York or Chicago or a lady in San Antonio, for that matter. There’s a couple in San Antonio. I think US Global is one I can think of. Frost Bank has mutual funds. So those are a couple institutions, not a lot in San Antonio, but there’s an actual person responsible for buying and trading stocks, and I get to as an advisor, I get to meet these people.
So, I get to sit down with them sometimes in my office, or many times I have to travel to Boston, Chicago, LA, New York and meet with them. And just to see the character of who they are, they’re all smart. There’s no doubt they’re all smart, it is just trying to understand, when I’m meeting with them, that there’s an alignment between the objectives and a little bit of character judgment in a short amount of time.
But a mutual fund is a person. And that’s part of the point I’m trying to make is a mutual fund is a person that’s responsible for buying and selling, and that person is human, and they make human judgment calls. And so, they will do a ton of research on a company. And sometimes they do so deep of research that it’s exciting for me.
Like, they will tell me that a CEO of XYZ company is about to retire in two years. So, you don’t want to own that stock right now. Like that stuff’s hard to find on computers, and that’s just from them having conversations. Speaking of Enron, I actually, American Funds decided not to invest in Enron. They were coming back on a plane from meeting with them.
I think I was at Houston and their notes, their analysts. An analyst is like they work for the fund manager. And their analyst note said, won’t invest, won’t shoot me straight. Concerned about the integrity of the leadership. That’s what a mutual fund does, is it screens out companies that might be problematic. The price of a mutual fund.
This is just worth noting. You don’t know the price of the mutual fund until the close of the business day. And then they do all the calculations to say this is the price. This is the value of that mutual fund. There are some minimums on mutual funds and they’re not too high, but maybe 5000 sometimes 10,000. And mutual funds, just like exchange traded funds, will pay out dividends.
The dividend rates, if you’ve seen over the years, have gone down considerably. And there’s still plenty of companies that pay dividends, but not like they used to. One of the biggest things that I’ve had, I’ve been challenged with as an advisor, that I’ve actually had clients upset with me for. And I get it is capital gains.
So, you can pay tax, you pay taxes on mutual funds, you can literally pay taxes on mutual funds where you didn’t make any money. It is absolutely the craziest game and very sensitive to that today. But there was a period of a decade where the whole industry was frustrated with this. And, it really led to the proliferation of exchange traded funds, probably the capital gains thing where clients were upset, advisors were upset, and of course, you can’t blame the clients for being upset at the advisor for not being able to navigate through this.
But the advisor was like, we would call the fund company, go, what are you doing? So, I think this capital gains issue, paying taxes on money you didn’t make, think about that, paying taxes on money you didn’t make. This was happening in the mutual fund industry, was part of the catalyst to the exchange traded funds.
Now exchange traded funds have the same last name funds. So, in essence they’re cousins right? It’s interesting commentary I was part of that Dave Ramsey network. I actually flew up to Nashville and had some interesting conversation with Dave and his team about the proliferation of exchange traded funds and how they are an important tool for clients and a go forward basis.
And Dave and his team were very open to the idea of, modifying the, I don’t want to speak on his behalf, but we were having good conversations about what does it look like in this next iteration of investing for Dave to say, Dave Ramsey, to say, okay, Dave is okay with you doing an exchange traded funds versus mutual funds, like so we’re asking ourselves that question.
Dave, I love Dave as a person and even as just a professional, but he’s going to stay with his game. He started with mutual funds and he’s going to stick with mutual funds. He had a hard time with exchange traded funds because they’re abused. And so, he didn’t want other people to abuse exchange traded funds.
How are they abused? Remember I said mutual funds, the prices of mutual funds are at the end of the day, exchange traded funds you can buy and sell throughout the day. So, if you freak out during the day, you can click and sell it. If Dave Ramsey does not want people to do that, as you would imagine, and people are doing this all the time, exchange traded funds are cousins to mutual funds.
They both have the same last name. The difference in exchange traded funds. There are several differences. The main difference in exchange traded funds is that they’re run by a computer. So, a computer and I’m using that facetiously is they will buy a bunch of stocks and they’ll leave them alone. They won’t go and look at the CEO and say, you know, is the CEO about to retire?
They don’t do that kind of research. They just say, buy, 50 stocks that have low debt or buy 50 stocks that are growing at a fast pace. And then they buy those for you. It’s mutually funded with thousands of people across the country. And then they buy that basket and then they basically leave it alone. They’re not buying and selling anymore.
They may do modifications to it, but they’re just leaving it alone. And the cost, by the way, the cost, let’s say, and I’m just rounding here, mutual funds have gone down in cost over the years, especially since the 80s. Oh my gosh, I’ve seen the cost come down considerably and some of that scales and efficiencies. But a lot of that’s the ETFs just putting pressure on them.
But mutual funds let’s say they cost 1% internal expense ratio. You don’t even see this by the way. It’s in the fund. Their equivalent exchange traded fund might cost 0.1%. And by the way that adds up over time. So exchange traded funds are considerably lower than mutual funds. That’s why if you look at trend charts, the exchange traded funds are trending way more rapidly than mutual funds.
Like not even close. But exchange traded funds, the low cost is really, really the advantage. And then some people, even institutions, are using them to buy and sell throughout the day. When you hear of an index, you’ve heard this thousand before, thousands of times before, own the S&P 500 index and call it a day. An index is like an exchange traded fund.
It’s like, almost you can use those names synonymously. And, you can buy an exchange traded fund that owns the S&P 500 index. Very low cost. And it’ll own 500. The S&P 500, I actually think it’s 498. But 500 companies, leave them alone and just let them do their thing. And you can buy that for an extremely low cost.
So, a lot of people love buying the S&P 500 index. And they would prefer doing that many, many people, Warren Buffett being one of them. That’s just as an example, would prefer buying an index. The S&P 500 index, maybe as an ETF versus owning a mutual fund with the person in New York who might charge more and here’s the kicker.
The majority of mutual fund managers with their suits in Chicago, wherever, the majority of them don’t even do better, they do worse. The majority of them do worse than their index or equivalent exchange traded fund index. I hope that didn’t confuse you. You may have to do some research, if that does throw you off.
But a mutual fund will typically underperform an exchange traded fund that’s just owning the index at a very low cost. That’s passive. That’s a key descriptive word. It’s passive. It’s not buying and selling all the time versus a mutual fund buying and selling all the time, charging more in fees but not performing as well.
So that’s another catalyst for exchange traded funds is not only that capital gain thing that was frustrating everyone, but the low cost and then outperformance of exchange traded funds. Then it gets really weird because, you know, I do research just like we all do. And I love Morningstar. That’s one of my favorite places to go to for fund research.
So, if you want to dig into this more, go to Morningstar. Tons of research articles. Awesome stuff. Love it. Out of Chicago, they’re publicly traded. But here’s where it gets really nuanced. I think an advisor can be very helpful here. Some areas of the market, it’s a no brainer. Like large companies, if you want to own large companies, the S&P 500 is pretty darn good.
Versus a mutual fund. You know, they’re just not outperforming. But it does get nuanced. Like for example, I was looking at bond funds. And I’ll put this research so you can have it in bond funds specifically, we’re looking at Pimco, not suggesting you buy Pimco using them as an example. 79% of their funds have actually outperformed after fees.
Their passive counterpart. So, when the rhetoric in the marketplace is that most mutual funds don’t do as good as ETFs, there are some pockets like maybe emerging markets, maybe bonds, that you might be better off getting a manager who can sometimes sniff out bad CEOs, sometimes they can make good judgment calls on currencies.
Sometimes they can find companies that are maybe rated triple B because of some balance sheet issues. But they find they’re a better company than is expressed in the marketplace. They can sniff out stuff. So, there are some areas where mutual funds can do better. And so, an advisor can work with a client to figure this out.
Okay, I know I’ve covered a lot but let me make sure I make this last point. Sometimes people say, they say, what do you invest in, well I invest in a 401k. You don’t invest in a 401k, you invest in mutual funds or exchange traded funds inside of a 401k. Your 401k is just a wrapper.
It’s a section of the code called 401, subsection K. It’s just a wrapper on the investments inside. Right. And so, you don’t invest in a 401k. You don’t invest in a Roth IRA. You don’t invest in IRA. You invest in funds. You should sometimes stocks, sometimes bonds, but you typically invest in funds that are inside of that wrapper 401k, that 401k, Roth IRA, traditional IRA.
That’s just a description to the IRS of how your money should and will eventually be taxed. So that’s the difference between mutual funds and exchange traded funds. I’d be happy to do part two if there’s some emails that come my way that say, hey, could you double click on to this area? Because it was confusing, but I covered a lot of ground that certainly subject to a ton of research and academic thought whitepapers.
If you want to do more digging, like I said, Morningstar is a good place to go at the end of the day. At the end of the day, I guess that’s always a good thing to say. Somebody told me at the end of the day is still the end of the day. At the end of the day, whether it’s mutual funds or ETFs, what really matters is that you’re saving and not making stupid decisions with your money.
That’s really what it boils down to, is just what we are collectively doing. If we wake up one day and say, man, I should have done ETFs or I should have done mutual funds, there’s definitely some advantages in working with your advisor on figuring that stuff out. But the main thing, is that you’re saving 15% of your gross income and that in terms of your retirement accounts, you’re not messing with it too much.
I think that’s the main point, that’s the one that you can control. Again, email me Darryl@PAXFG.com for further discussion. And remember you think different when you think long term. Have a great day.
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