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Episode 134 – Mutual Funds vs. ETFs: Understanding the Differences That Matter to Your Portfolio

Insights from Last Paycheck Podcast Episode 134

If you have invested at any point in your life, chances are you have owned a mutual fund, an exchange traded fund, or both. These two investment vehicles dominate retirement accounts, brokerage portfolios, and employer plans. Yet despite their popularity, many investors do not fully understand how they differ or why one may be more appropriate than the other in certain situations.

In Episode 134 of the Last Paycheck, hosts Archie Hoxton and Rob Hoxton, CFP professionals at Hoxton Planning & Management, break down mutual funds and ETFs in a clear, practical way. Rather than treating one as inherently better, they explain how each works, where each excels, and how thoughtful investors and advisors often use a combination of both.

A Shared Goal: Diversification for Everyday Investors

Mutual funds were created to solve a fundamental problem. How can an ordinary investor gain diversified exposure to many stocks or bonds?

Instead of needing hundreds of thousands of dollars to buy dozens of individual securities, investors could pool their money. A professional manager would then build and manage a diversified portfolio according to a stated investment objective. This innovation made diversification accessible to everyday investors for the first time.

ETFs share that same goal. Both vehicles allow investors to gain broad exposure to markets, sectors, or strategies with a single investment. The differences lie not in the objective, but in the structure.

How Mutual Funds Work

Traditional mutual funds have been around since the early twentieth century and became formally regulated under the Investment Company Act of 1940. Historically, most mutual funds were actively managed. Investors would contribute money, and a fund manager would select securities based on a defined strategy.

Mutual funds are priced once per day, after the market closes. When investors buy into a fund, the manager uses cash to purchase securities. When investors redeem shares, the manager must sell securities to raise cash.

This structure works well in many respects, but it comes with tradeoffs, particularly when it comes to taxes in non-retirement accounts.

The Tax Surprise Many Investors Do Not Expect

One of the most eye-opening parts of this episode centers on capital gains distributions.

During periods of market stress, such as the 2008 financial crisis, many investors watched the value of their mutual funds decline sharply. Despite those losses, some investors were still required to pay capital gains taxes at year-end.

How does that happen?

As investors panic and redeem shares, fund managers are forced to sell holdings to meet redemptions. Those sales can trigger realized capital gains inside the fund. By law, those gains must be passed through to remaining shareholders, even if the overall value of the fund has declined.

For investors in taxable accounts, this can be both confusing and frustrating.

How ETFs Are Structured Differently

Exchange traded funds were developed later and use a fundamentally different mechanism.

Instead of buying and selling directly with the fund company, investors trade ETFs on an exchange throughout the day, just like stocks. When one investor sells, another investor buys. The underlying securities usually do not change hands.

Behind the scenes, ETFs use what is called in-kind trading. Large institutional participants exchange baskets of securities for ETF shares. Because securities are swapped rather than sold, capital gains are generally not triggered.

This structure makes ETFs significantly more tax efficient in taxable accounts.

Cost and Efficiency

ETFs initially gained popularity because they were often designed to track indexes. Index-based investing reduced management costs, which led to lower expense ratios across the industry. That cost pressure ultimately benefited mutual fund investors as well, driving fees down across both structures.

Today, both mutual funds and ETFs can be low cost, particularly when tracking broad indexes. However, ETFs often retain a slight advantage in terms of tax efficiency and intraday pricing flexibility.

Active vs. Passive Management

While ETFs were once almost exclusively passive, that is no longer the case. Actively managed ETFs now exist across many asset classes. That said, mutual funds still offer a wider universe of active strategies simply because they have been around longer.

Rob Hoxton explains how advisors often use both vehicles strategically. In highly efficient asset classes , such as large U.S. companies, low-cost passive ETFs may make the most sense. In less efficient asset classes, such as small-cap stocks or emerging markets stocks, active mutual funds or active ETFs may provide an advantage.

This is not about choosing sides. It is about choosing tools.

Other Practical Differences to Consider

There are additional nuances investors should understand.

Mutual funds trade once per day, which can be beneficial for investors who prefer simplicity and are less concerned with intraday price movement. ETFs trade throughout the day, offering flexibility but also requiring more attention when placing trades.

Mutual funds can also be more forgiving if a trade error is made. ETFs behave like stocks, where timing and pricing matter.

The Bigger Picture

As Archie and Rob emphasize, neither mutual funds nor ETFs are inherently superior. Each has strengths and weaknesses. The right choice depends on the type of account, tax considerations, investment goals, and the role each investment plays within a broader financial plan.

The most important takeaway is that investment vehicles should support your plan, not drive it.

Your Next Step

If you are unsure whether your current investments are structured in the most tax-efficient and strategic way, clarity is the first step.

Hoxton Planning & Management offers a Retirement Readiness Checklist to help you evaluate how your investments, accounts, and income strategy fit together. It is a practical tool for identifying gaps and asking better questions.

You may also choose to schedule a complimentary conversation with the Hoxton team to review your portfolio and understand how mutual funds and ETFs are being used within your plan.

Move from information to intention.

Download the Retirement Readiness Checklist or schedule your meeting.
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Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, and CFP® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.