Should one invest in Mutual Funds versus ETFs?
Most of our money is generally in Mutual Funds because 401k plans mostly offer Mutual Funds only.
MFs are Open-Ended Funds – since you get a share of the fund and the fund does not have an entity other than the fact that it is investing pooled money.
Some fund companies do NOT offer ETFs but only offer Open-Ended Mutual Funds such as T. Rowe Price – one of the best investment houses around!
Before investing in MFs, you must beware of some of its strange tax consequences!
Even while holding, you will have a tax liability on MFs.
As a result of the above, I don’t advise holding MFs in a taxable account. If you are really tempted to buy a specific fund then buy it early in the year and ease in.
If you end up buying a fund towards the end of the calendar year, here is a likely scenario – let’s say you buy the fund for $10 and they share a capital gain of $2 with you. If the price goes down to $8, you will be taxed for the $2 even though it may just be the return of capital. At the end of it all, you really did not get anything but you ended being taxed for it.
Here is a rule that I live by:
Taxable account – buy ETFs.
Tax-sheltered accounts like IRAs, Roth IRAs, and 401ks – buy Mutual Funds.
High Growth Stocks and MFs – Buy-in Roth IRAs which grow tax-free.
If you are doing an asset allocation, you may want to look at all your portfolios to decide your target – that is a discussion for another day!
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