Author Topic: Index Funds vs. Index ETFs in Taxable Accounts - TLH?  (Read 4872 times)

BrickByBrick

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Index Funds vs. Index ETFs in Taxable Accounts - TLH?
« on: February 02, 2017, 10:40:18 AM »
Hello all,

I've recently reached the point where I now have the additional money to invest into a taxable account (having already maxed out 401ks and IRAs going forward).  I recently transferred my first few thousand into a Vanguard taxable account and will begin buying more index stock funds/ETFs per my allocation but I'm wondering about the potential implications of buying Vanguard Index Funds vs . Index ETFs.

From what I've read online so far the differences between buying Vanguard Index Funds or equivalent ETFs seems to be almost nil in the end.  But is that a correct conclusion?  Specifically in regards to a taxable account are there particular advantages of one over the other?  Something that comes to mind is potential tax-loss harvesting.  Are index ETFs and regular index funds treated any differently in regards to that?

Thanks all for the thoughts.  I'm new to taxable accounts and just trying to keep mistakes to a minimum.

Hargrove

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Re: Index Funds vs. Index ETFs in Taxable Accounts - TLH?
« Reply #1 on: February 02, 2017, 07:54:22 PM »
I was having difficulty understanding this as well, but I think mostly it's unimportant in a non-taxable account. Taxable is another story.

In a taxable account, according to MMM, tax-loss harvesting is worth a few thousand on a big portfolio, which makes the index the easy winner. This is based on his study with Betterment, and he believed that the tax-loss harvesting was worth both Betterment's NEW fee AND gains on top of it. Then there's commission on ETFs if you pay it. TDAmeritrade does free VTI but not VXUS, and free DRIP too. I think the chief reason to buy the ETFs is if you don't have a Vanguard account.

For other readers curious about this for non-taxable accounts...

ETFs based on Vanguard Index Mutual Funds vs ETFs simply named "Vanguard... index fund" are roughly equally safe (it would take an apocalypse to close out either of them and their growth will be extremely close).

Tax implications don't really matter in non-taxable accounts, so a fund is as good as an ETF there.

Some people talk about "reinvestment drag," or the time it takes money to be reinvested from gains in one vs. the other investment vehicle, but this seems like something I can't be bothered to worry about - the growth rates appear to be the same or similar, which seems to suggest there's not much investment dragging going on. My broker will DRIP if I want, back into an ETF, with a delay no longer than a day after being paid, which comes to a whopping two days. I guess you could calculate a loss of 4%(24/365.25)*(average annual deposit) in an ETF for that, which would be $2.63 a year (plus compounding) on 1k monthly deposits in ETF fees, but only if we're comparing it to an alternative rate of Immediate Reinvestment™ (which probably doesn't exist).

You would have the opportunity to use a stop-loss order in the market on your ETF to try to hedge against losses in a slump, where you couldn't with the fund, but you wouldn't admit to market timing here...

The last reason is commissions. If you pay a commission on VTI and VXUS or whatever you're using, you save (commission+(compounding on commission))*(number of times you traded your ETFs) for using the fund instead of the ETF.

TL;DR: Do you have 10k? Open a Vanguard account and get the funds. If not, buy commission free ETFs at one of the many brokers offering them now.

NoStacheOhio

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Re: Index Funds vs. Index ETFs in Taxable Accounts - TLH?
« Reply #2 on: February 03, 2017, 08:20:59 AM »
IIRC, Vanguard has their share classes structured in such a way that it's better to hold the mutual funds in taxable, because capital gains get distributed through the ETFs. With other providers I think it's the reverse.

https://www.bogleheads.org/wiki/ETFs_vs_mutual_funds

As far as TLH, you just need to avoid wash sales. So if you sell VTSAX at a loss, you can't buy VTI because it's substantially similar. You can buy VOO because it tracks a different (but highly correlated) index. After 30 days you could move the money back to VTSAX/VTI.

BrickByBrick

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Re: Index Funds vs. Index ETFs in Taxable Accounts - TLH?
« Reply #3 on: February 03, 2017, 08:35:37 AM »
Thank you both, sounds like index funds are the way to go in a taxable account, specifically because it will be Vanguard index funds in a Vanguard account.

NoStacheOhio

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Re: Index Funds vs. Index ETFs in Taxable Accounts - TLH?
« Reply #4 on: February 03, 2017, 08:53:58 AM »
Thank you both, sounds like index funds are the way to go in a taxable account, specifically because it will be Vanguard index funds in a Vanguard account.

Just to be pedantic, VTI is an index fund AND an ETF. Index fund is a more generic term that refers to investment products that aim to hold all of the assets in a particular index. The structure of the fund (ETF or mutual) doesn't change whether or not it's an index fund.

Indexer

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Re: Index Funds vs. Index ETFs in Taxable Accounts - TLH?
« Reply #5 on: February 04, 2017, 08:50:29 AM »
Anywhere BUT Vanguard:  Index ETFs are more tax efficient than index mutual funds.

At Vanguard: The admiral share class of the mutual fund and the ETF should be the same cost and tax efficiency(there is at least one fund where the admiral share is cheaper than the ETF). This is because the ETFs are another share class of the existing mutual funds.

VTI and VTSAX are invested in the same thing, equal cost, equal tax efficiency, etc. The difference is how you trade them. VTSAX trades as a mutual fund, in dollars and it is priced at the close of business. VTI trades like a stock. There are pros and cons to this. VTI can be traded at anytime the market is open, but you have to buy whole shares and there is a bid-ask spread. This means you are always paying slightly more(normally pennies) and you can't have automatic investments/withdrawals with the ETF.

For long term investing, if you have at least $10,000 to invest in the fund, go with the admiral share.

Tax loss harvesting: with the ETF or mutual fund you can sell existing shares by 'average cost' or 'specific ID.' Average looks at every share you have bought ever and averages them. Specific ID lets you say you are selling the share you bought on Jan 20th, 2017 which is at a loss, without selling the shares you bought in 2016 which are all at gains.

heymaverick

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Re: Index Funds vs. Index ETFs in Taxable Accounts - TLH?
« Reply #6 on: May 03, 2017, 03:39:40 PM »
I'm so happy I found this post which explained exactly what I was also wondering about. I'd recently set up a Vanguard account for taxable funds, and the cash was in a 'settlement account' there waiting for me to invest, and when it came time to pull the trigger today, I discovered that VTI 'traded like a stock' and wouldn't allow me to do some of the things I think I'll want to be able to do like 'auto invest' (down the road) and be able to buy with lump sums rather than to the penny of a specific whole share amount, and this discussion shed light on those differences. It sounds like with the mutual fund version of VTI (not the ETF), I could invest a lump sum whenever I wanted to (and had the cash to do so) w/out having to buy in whole shares. The Mutual Fund version of VTI is called VTSAX, correct?

Next up I will be transferring our existing SEP and existing ROTH IRA (currently earning very little at in a Fidelity cash account and a credit union account earning 1%)  to Vanguard, so I will need to determine how to best set those up as far as ETF or mutual fund. If you have any vanguard specific advice for how to do that for our SET & Roth IRA, please let me know. I also have a new betterment account but I'm thinking Vanguard would be better for our SEP and Roth IRA - is that right? Thanks so much for starting this conversation back in February - it's helping me now in May : )

ooeei

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Re: Index Funds vs. Index ETFs in Taxable Accounts - TLH?
« Reply #7 on: May 04, 2017, 06:38:32 AM »
You would have the opportunity to use a stop-loss order in the market on your ETF to try to hedge against losses in a slump, where you couldn't with the fund, but you wouldn't admit to market timing here...

I seem to recall every couple years or so there's a "flash crash" due to some weird computer driven buying/selling spree that resolves itself usually within the same day.  There's always a story or two that comes out about someone who lost huge chunks of money due to stop loss orders.