Author Topic: What is the difference between an index fund and its ETF version?  (Read 3744 times)

CientoUno

  • 5 O'Clock Shadow
  • *
  • Posts: 40
  • Age: 31
  • Location: Roi Et, Thailand
Up next in the "CientoUno's Really Newbie Questions" series:

Can someone explain (the "For Dummies" version, please) the difference between an index fund and its ETF version?

Let's use VTSAX/VTSMX and VTI. I understand what an index fund is, and the difference between VTSMX and VTSAX. One is for a lower invested amount with a correspondingly different expense ratio. But what's different about VTI? What makes it different from VTSMX/VTSAX? What are the advantages/disadvantages to an ETF vs investing in a standard index fund?

Thank you! This community really has taught me a lot. My future financial independence will be due in no small part to you fine folks, truly.

Heckler

  • Handlebar Stache
  • *****
  • Posts: 1364
Re: What is the difference between an index fund and its ETF version?
« Reply #1 on: January 28, 2016, 12:15:56 AM »
An ETF is an Exchange Traded Fund, bought and sold on a stock exchange (NYSE, TSX), the same place you can buy Apple or GM stock.

Mutual fund is sold to you by a broker, in this case Vanguard.  The broker in turn would buy the stocks that make up the fund on an exchange and do the math for his costs, giving you the difference in returns.


MDM

  • Senior Mustachian
  • ********
  • Posts: 10473

MustacheAndaHalf

  • Magnum Stache
  • ******
  • Posts: 3207
Re: What is the difference between an index fund and its ETF version?
« Reply #3 on: January 28, 2016, 01:59:09 AM »
ETFs are part of the stock market, while mutual funds are "offline".

If you go to any brokerage in the US, you can buy a stock called "VTI" which is actually Vanguard Total Stock Market ETF.  While the market is open, people place buy and sell orders at brokerages around the US (world?) to trade "VTI".

Once the market has closed for the day (gone "offline"), mutual fund VTSAX conducts it's business.  It calculates how much it's holdings are worth, which determines the price of VTSAX for the day.  All the orders from people wanting to buy and sell are then conducted at that price.

capitalninja

  • Stubble
  • **
  • Posts: 102
  • Know what the other guy is making on the deal...
    • Entrepreneur, Investor, Life Advice
Re: What is the difference between an index fund and its ETF version?
« Reply #4 on: January 28, 2016, 10:14:52 AM »
For an investor VTSAX/VTSMX and VTI are essentially the same save fees.  The value of the ETF changes throughout the trading day. The value of the mutual funds changes once per day after closing.

For the mutual funds, one is investor and the other is "Admiral" with the only difference being the fees paid. If you have less money to invest, the ETF is usually a good bet as the minimum buy in is the price of a single share.

With the exception of fees, they're all pretty much the same.

Geekenstein

  • 5 O'Clock Shadow
  • *
  • Posts: 34
Re: What is the difference between an index fund and its ETF version?
« Reply #5 on: January 28, 2016, 05:58:09 PM »
I'm sure this is considered a given but I'll throw it out there.

Buying mutual funds is easy.  As mentioned above buying an ETF is like buying a stock.  Because that is true, you have to consider how you will buy.  There are several different types of orders.  It's good to know which is which, because on days where there is high volatility, you may want to have control over the price you buy (or sell) at.


https://en.wikipedia.org/wiki/Order_(exchange)

CientoUno

  • 5 O'Clock Shadow
  • *
  • Posts: 40
  • Age: 31
  • Location: Roi Et, Thailand
Re: What is the difference between an index fund and its ETF version?
« Reply #6 on: January 28, 2016, 07:28:21 PM »
https://www.bogleheads.org/wiki/ETFs_vs_mutual_funds might be helpful.

That link was indeed super helpful. Thank you very much, basically answered all my questions. Seems to me that for someone in my position I couldn't do wrong either way. Here's a hypothetical situation: if I plan on investing $5,000 to get started, might there be something to be said for going with VTI for the lower expense ratio than VTSMX? And then once I got to 10K I could switch over to VTSAX if I desired.

MDM

  • Senior Mustachian
  • ********
  • Posts: 10473
Re: What is the difference between an index fund and its ETF version?
« Reply #7 on: January 28, 2016, 07:51:44 PM »
... if I plan on investing $5,000 to get started, might there be something to be said for going with VTI for the lower expense ratio than VTSMX? And then once I got to 10K I could switch over to VTSAX if I desired.
The annual difference between VTI and VTSMX for a $5000 balance is $6.  Up to you....

CientoUno

  • 5 O'Clock Shadow
  • *
  • Posts: 40
  • Age: 31
  • Location: Roi Et, Thailand
Re: What is the difference between an index fund and its ETF version?
« Reply #8 on: January 28, 2016, 07:56:15 PM »
... if I plan on investing $5,000 to get started, might there be something to be said for going with VTI for the lower expense ratio than VTSMX? And then once I got to 10K I could switch over to VTSAX if I desired.
The annual difference between VTI and VTSMX for a $5000 balance is $6.  Up to you....

Haha fair point.

Indexer

  • Handlebar Stache
  • *****
  • Posts: 1463
Re: What is the difference between an index fund and its ETF version?
« Reply #9 on: January 28, 2016, 08:21:08 PM »
Outside of Vanguard there is a big difference. ETFs are normally cheaper.

At Vanguard they are basically the same. VTI and VTSAX are the same investment. You just trade them different.

VTSAX is traded at the end of the day in dollars. So you can invest exactly $10,000.
VTI is traded in real time(or close to it) in shares. So you can buy 100 shares or 99 shares, but it likely won't be exactly $10,000.

ETFs also don't always trade at their NAV. Normally they are really close, but sometimes there can be a variance. This means you might end up paying a little more for an ETF. The ETF can also get a lower cost if you are investing less than 10k.

So IMO the mutual fund is better. The ETF is good if you need to trade intraday, but if you are investing for a 20 year time frame why do you care if you buy at 2pm or 4pm on Tuesday?

johnny847

  • Magnum Stache
  • ******
  • Posts: 3192
    • My Blog
Re: What is the difference between an index fund and its ETF version?
« Reply #10 on: January 28, 2016, 09:15:06 PM »
https://www.bogleheads.org/wiki/ETFs_vs_mutual_funds might be helpful.

That link was indeed super helpful. Thank you very much, basically answered all my questions. Seems to me that for someone in my position I couldn't do wrong either way. Here's a hypothetical situation: if I plan on investing $5,000 to get started, might there be something to be said for going with VTI for the lower expense ratio than VTSMX? And then once I got to 10K I could switch over to VTSAX if I desired.

On top of what MDM said, if you're doing this in a taxable account, you'd have to pay taxes to switch from VTI to VTSAX, because you'd have to sell your shares of VTI to switch them to VTSAX.

Incidentally, it is possible to convert your mutual fund shares to ETF shares without incurring any taxes (via a Vanguard patent), but you cannot do the reverse.