Why ETFs?

[forummm]

As a buy-and-hold long-term investor, is there any reason to buy Vanguard ETFs instead of the related index fund? I've seen at least one forum member talk about his portfolio being entirely Vanguard ETFs.

[GGNoob]

For me and my smaller portfolio, it allows me to hold the funds I want without the $3k minimum per fund. It also gives me the lower cost of the admiral shares.


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[wtjbatman]

As a buy-and-hold long-term investor, is there any reason to buy Vanguard ETFs instead of the related index fund? I've seen at least one forum member talk about his portfolio being entirely Vanguard ETFs.

You meant to say related mutual fund. ETFs (exchange traded funds) can, and usually do, follow an index.

For example my IRA at TD Ameritrade is primarily Vanguard index ETFs. Ditto my other IRA at Sharebuilder.

Like Logan said, there are real tangible benefits to investing in ETFs, especially when starting out. Or if you don't have an account directly with a mutual fund/ETF provider like Vanguard or Fidelity.

[GGNoob]

As a buy-and-hold long-term investor, is there any reason to buy Vanguard ETFs instead of the related index fund? I've seen at least one forum member talk about his portfolio being entirely Vanguard ETFs.

You meant to say related mutual fund. ETFs (exchange traded funds) can, and usually do, follow an index.

For example my IRA at TD Ameritrade is primarily Vanguard index ETFs. Ditto my other IRA at Sharebuilder.

Like Logan said, there are real tangible benefits to investing in ETFs, especially when starting out. Or if you don't have an account directly with a mutual fund/ETF provider like Vanguard or Fidelity.

I also have 2 retirement accounts at TD Ameritrade (work 401k and 457). So my best option there was the commission-free Vanguard index ETFs.


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[MrFrugalChicago]

Compare the funds over say 10 years. I THINK vanguard ETFs have a little lower fees, so a little better tracking.. something like .01-.02% per year range. Not a huge difference for sure.

[innerscorecard]

ETFs are in general more tax-efficient because they don't have to distribute capital gains unlike mutual funds. In additional to dividend distributions, you realize your capital gains only on the sale of the ETF.

[Dodge]

ETFs are in general more tax-efficient because they don't have to distribute capital gains unlike mutual funds. In additional to dividend distributions, you realize your capital gains only on the sale of the ETF.

Vanguard's funds are an exception.  This is their VTSAX (Total Stock Market Index Fund) performance page:



And this is their VTI (ETF version of the fund above) performance page:



We see the after tax difference is either 0.01% higher for ETFs, or tied, and one time the fund was higher.  However, when we consider that you have to deal with the spread when buying/selling ETFs, and that the spread typically gives you a penalty that's "typically in the 0.01% - 0.1% range (varying with fund size and popularity)" both when you buy and when you sell, we see that there is no tax advantage for ETFs when using Vanguard.  Bogleheads explains that ETFs are typically more tax efficient, but "The exception is Vanguard's dual-share fund structure, which allows their index funds to be just as tax-efficient as ETFs."

http://www.bogleheads.org/wiki/ETFs_vs_mutual_funds#Tax_efficiency

Personally, I choose the fund over the ETF, as the expense ratio is the same for me, I don't want to deal with the spread of an ETF (it makes ETFs more expensive, even for the same ER), I like buying/selling in fractional shares (you can only buy the ETFs in whole amounts, so there will always be some money sitting on the side), and I like to use Automatic Investing, which is not available for ETFs.

To highlight the expense difference, Vanguard made a nice comparison tool:

https://personal.vanguard.com/us/faces/JSP/Funds/Tools/FundsToolsEtfCostPurchInfoContent.jsp



Which shows that the fund ended up being a tiny bit cheaper based on the numbers I put in:



So it isn't a big difference, but I didn't see any advantage to ETFs anyway, so going with the fund was an easy choice.

[maki]

dodge +1

[seattlecyclone]

In general I prefer the mutual funds because there's no bid/ask spread to deal with and the expense ratios are generally the same. However if you don't want to invest enough in a particular fund to qualify for Admiral shares, the ETFs can give you the same expense ratio with no minimum investment. Also Vanguard has a few mutual funds with purchase and/or redemption fees (intermediate-term corporate bonds, long-term corporate bonds, emerging market government bonds, international real estate). You can avoid these fees by purchasing the ETF instead of the mutual fund.

[RapmasterD]

Thanks for stimulating my brain, Dodge.

I have absolutely never considered the bid-ask spread.

While it will not change my behavior wholesale (the cost difference is indeed quite small and for infrequent traders super duper small), it is definitely an interesting consideration.

[forummm]

I found this Vanguard brief to be educational. There are some potential pitfalls to using ETFs that you don't have when buying mutual funds. I think I would only buy an ETF if I didn't have enough money for the fund minimum, and wouldn't accumulate that much money in a short time period. Given the low minimums for nearly all Vanguard funds and the savings from a mustachian lifestyle, it seems rare that many of us would be in that situation.

https://advisors.vanguard.com/iwe/pdf/ISGETF.pdf?cbdForceDomain=true

[Left]

I forget where I read it or if it is even accurate, but I read that with mutual funds, when they rebalance themselves, it is a taxable event for the fund owners. ETFs aren't taxed until they are sold (hopefully at cap gain rate) so the rebalancing event doesn't take place. That said, I don't know of an ETF that keeps an AA like the balanced fund, but might affect something like VT or VTI if they are balancing the caps?

edit: maybe my wording isn't right when I say rebalancing, I guess just any movement within the fund is taxed on mutual funds and not etf

[PEIslander]

Although what has been noted about spreads is true, I still like ETFs because I can make buys or sell transactions based on current market conditions.

If you decide this morning to buy, say, $1000 worth of a particular mutual fund, you won't know how many units you actually bought until the transaction settlement. Mutual fund settlements are typically delayed. At times of market volatility that delay can result in a significantly different unit price that when you decided to buy (or sell). Those differences can be significantly more expensive to you than the spread on an ETF would ever be! Likewise if you decide to buy, say, 1000 units of a mutual fund you don't know how much you've paid until the transaction settlement. Transaction settlements with mutual funds can be as much as three days although usually less. Whatever the delay - its a long time to wait to actually know what price you paid or how many units you bought. In this context it is kind of comical to hear mutual fund holders express concern over the spreads in ETF transactions as if they are a reason not to buy ETFs.

So to me the spread you can see during an ETF trade is much more desirable than the relatively blind situation of the typical mutual fund transaction.

[PEIslander]

I read that with mutual funds, when they rebalance themselves, it is a taxable event for the fund owners. ETFs aren't taxed until they are sold...

What you write is true when mutual funds and ETFs are held in taxable accounts but is not generally important in non-taxable accounts. I have some mutual funds I've held in taxable accounts for many years. I've had them long enough to see years with great performance and others with negative returns. Years with negative returns are painful but it really turns the screws to have those negative years also have capital gains that have to be declared and taxes paid. Yes, the investment has dropped in value (sometimes significantly) but you also have to pay taxes. The taxable gains relate to rebalancing in a index-related fund and turnover in a more managed fund. In years with major market corrections fund managers in actively managed funds can have significant increases in their turnovers as they reposition themselves to take advantage of the changing market conditions. That can result in lots of capital gains --- that they transfer to the unit holders with the thinking that it is better for unit holders to pay the taxes at relatively low personal rates than have the fund pay the taxes (likely at a higher rate) and further degrade the unit price.

From experience I can say it can be difficult to review your actual performance of mutual funds held in taxable accounts. You know how much money you put in & you know what its worth today but it is hard to keep track of what tax you've paid over the years. In that regard, it is much easier to review your true performance with ETFs (particularly ones without dividend yield).

[Indexer]

I forget where I read it or if it is even accurate, but I read that with mutual funds, when they rebalance themselves, it is a taxable event for the fund owners. ETFs aren't taxed until they are sold (hopefully at cap gain rate) so the rebalancing event doesn't take place. That said, I don't know of an ETF that keeps an AA like the balanced fund, but might affect something like VT or VTI if they are balancing the caps?

edit: maybe my wording isn't right when I say rebalancing, I guess just any movement within the fund is taxed on mutual funds and not etf

This is a common misconception.  It has little to do with the ETF and a lot to do with the 'index'.  ETFs are normally index funds.

Active mutual funds and AA funds have to do a lot of buying and selling.  Each time they do this they create gains/losses.  These gains/losses get passed on to the investor.

Index funds(and ETFs by extension) don't do a lot of buying and selling so they are less likely to generate capital gains. 

And VTI/VTSAX(same fund) don't really have to rebalance the caps.  They just own almost all stocks in the US in their market weightings.  If a stock grows its weighting grows, and the opposite if it shrinks. 

[forummm]

I forget where I read it or if it is even accurate, but I read that with mutual funds, when they rebalance themselves, it is a taxable event for the fund owners. ETFs aren't taxed until they are sold (hopefully at cap gain rate) so the rebalancing event doesn't take place. That said, I don't know of an ETF that keeps an AA like the balanced fund, but might affect something like VT or VTI if they are balancing the caps?

edit: maybe my wording isn't right when I say rebalancing, I guess just any movement within the fund is taxed on mutual funds and not etf

This is a common misconception.  It has little to do with the ETF and a lot to do with the 'index'.  ETFs are normally index funds.

Active mutual funds and AA funds have to do a lot of buying and selling.  Each time they do this they create gains/losses.  These gains/losses get passed on to the investor.

Index funds(and ETFs by extension) don't do a lot of buying and selling so they are less likely to generate capital gains. 

And VTI/VTSAX(same fund) don't really have to rebalance the caps.  They just own almost all stocks in the US in their market weightings.  If a stock grows its weighting grows, and the opposite if it shrinks.

Yes. And this is not true for most passively indexed Vanguard funds in general because of the dual share structure. They use the ETFs to distribute the capital gains, so mutual fund holders don't have them. The actively managed funds turnover more, so they sometimes pass along gains.

[aj_yooper]

In Vanguard, ETFs, when sold, take a few days for the net proceeds to be available so you cannot purchase anything until then.  With V funds, you can trade into the new fund and out of the old in the same day; the notifications of the final sale take a few days.  Some sectors are only available in funds and some in ETFs only. 

I generally prefer funds.

[PEIslander]

I forget where I read it or if it is even accurate, but I read that with mutual funds, when they rebalance themselves, it is a taxable event for the fund owners. ETFs aren't taxed until they are sold (hopefully at cap gain rate) so the rebalancing event doesn't take place. That said, I don't know of an ETF that keeps an AA like the balanced fund, but might affect something like VT or VTI if they are balancing the caps?

edit: maybe my wording isn't right when I say rebalancing, I guess just any movement within the fund is taxed on mutual funds and not etf

This is a common misconception.  It has little to do with the ETF and a lot to do with the 'index'.  ETFs are normally index funds.

Active mutual funds and AA funds have to do a lot of buying and selling.  Each time they do this they create gains/losses.  These gains/losses get passed on to the investor.

Index funds(and ETFs by extension) don't do a lot of buying and selling so they are less likely to generate capital gains. 

And VTI/VTSAX(same fund) don't really have to rebalance the caps.  They just own almost all stocks in the US in their market weightings.  If a stock grows its weighting grows, and the opposite if it shrinks.

Indexer - what is it that you see as the "common misconception"?  Dividends & capital gains distributions from a mutual fund are taxable events if the fund is held outside a tax-sheltered account. Same for ETFs. I agree that index-based mutual funds & ETFs are typically less likely to generate capital gains distributions vs. more actively-managed investments. This isn't to say that capital gains distributions when they do happen are bad - just that they can be taxable. In my earlier posting I noted that sometimes, as I have experienced firsthand, you can owe taxes on an investment even though the value of the investment has gone down. Tax sheltered accounts make our lives much simpler.

[GGNoob]

In Vanguard, ETFs, when sold, take a few days for the net proceeds to be available so you cannot purchase anything until then.  With V funds, you can trade into the new fund and out of the old in the same day; the notifications of the final sale take a few days.  Some sectors are only available in funds and some in ETFs only. 

I generally prefer funds.

When I sell my Vanguard ETFs in my Roth, the funds are available instantly to buy something new. However, I cannot sell those new ETFs until the proceeds from the first sale have settled.

[Left]

What you write is true when mutual funds and ETFs are held in taxable accounts

Yes, but I still don't see the "importance" of having mutual funds outside of fractional shares. So I use ETFS in tax advantage accounts for simplicity too. Sure, I can invest ALL my money and not be short 1 share because I didn't have enough for next whole share in an ETF. But I don't mind not having 1 share less. And since I don't use vanguard as a broker, mutual funds have higher transaction fees for me as well :S. That said, I do keep the balanced mutual fund in 401k because it auto-balances for me to make it simple (I have option to do it myself but why bother when I like that AA?).

Another thing I noticed is that it was easier to trade ETFs "in kind" between brokers than I could with mutual funds, but this might be in this one case for me, I haven't tried it again/other times. I worry about this since I plan to keep my money across different investment companies later on in my investment life.

IE: it's easier to get to one broker while oversea, etc. And I like brick/mortar near me when I deposit/get money (yeah yeah, I'm not in the internet age in this respect yet)

[capitalninja]

With the exception of VGHCX, and my 401k funds, all of my investment portfolio is ETFs.  The primary reason is lower expense ratios along with the flexibility to buy throughout the day at the price I want.

By going with ETFs, you get the same ER as you do with Vanguard's Admiral funds and in my opinion there's a bit more control over the price you pay. With the exception certain international ETFS (VSS in particular) the bid-ask spreads for Vanguard ETFs is negligible. Over the long term it certainly doesn't matter.

In the end you won't go wrong either way. It's not like we're talking hundreds of thousands of dollars difference in net result.

Most people end up broke in their later years more as a function of failing to invest consistently rather than the particular vehicle they choose for investment. The fact that you're actually taking the time to think about this stuff already puts in front of 95% of the population.

[johnny847]

I think the biggest reason to use mutual funds instead of ETFs, when we are talking about those from Vanguard (because as forummm said, Vanguard does some magic (which is actually patent protected until 2023, btw) to disburse capital gains incurred in the mutual funds into the ETF versions, where the customer only realizes those capital gains upon selling the ETFs) is the ability to have automatic investment. Because a mutual fund is priced only once per day, and you can buy fractional shares, you can set up automatic investment. Vanguard even has a direct deposit service, where you can directly deposit your paycheck to your Vanguard account (taxable or IRA). This is most effective if your employer lets you split your paycheck into several accounts.

I think technically speaking, automatic investment with ETFs is feasible if you use market orders, and just let the turd cash sit in a money market account. However, I have yet to see such a service, because market orders are generally not advised.

[Left]

scottrade lets me auto invest the dividends monthly. i can pick 80% vti, 20% blv to keep my aa. but aa is off a bit this way because of the different growth.

[aj_yooper]

This is from Forbes at http://www.forbes.com/sites/feeonlyplanner/2011/05/16/an-etf-quirk-that-could-hurt-your-portfolio/

"One important factor is the relationship between ETF settlement dates as they relate to the other investments in your portfolio. ETFs are transacted like stocks on stock market exchanges. Due to that fact, a potential problem comes into play with different settlement time periods for various types of investments.

Most traditional mutual funds will settle on the next business day (known as T+1) after an investor places a transaction (assuming the transaction is placed during normal business hours, and before a fund company’s cut-off time). This means that when you sell a traditional mutual fund, you can generally withdraw or transact your money again on the business day after you place the sale. Stocks and ETFs on the other hand settle on the third business day (T+3) from the date the transaction is placed. Because of this, there is a possible delay in being able to move from one investment vehicle to another.

Let’s say you hold the Vanguard Emerging Markets ETF (NYSE: VWO) which you want to sell and add to a current position in the Vanguard 500 Index (VFINX) mutual fund. You place a sale of the ETF on a Monday to settle on Thursday. The earliest that the order can be placed to buy the 500 Index is Wednesday in order for the settled funds to be available on Thursday. If VWO or VFINX has increased since the time you placed the sale until Wednesdays close, then you’ve missed out.

The problem only applies in this scenario, since in the reverse – where you trade the mutual fund for the ETF – the fund settles before the ETF, and the ETF purchase can be placed alongside the fund sale. Many brokerages will allow you to place offsetting transactions for a buy and sale of securities that settle on the same day. So a swap of one ETF for another ETF may not require waiting until the sale (first transaction) is settled before placing a buy, since settlement of the cash in the sale occurs on the same date as the buy. (Call your broker to confirm this is true on your account, as not all investment houses will allow individual investors to trade in unsettled funds.)"   This is what I have encountered in my tax sheltered Vanguard account.

[johnny847]

scottrade lets me auto invest the dividends monthly. i can pick 80% vti, 20% blv to keep my aa. but aa is off a bit this way because of the different growth.

If this was meant as a reply to me, I was not talking about dividends. I was talking about investing your cash into ETFs or mutual funds.

[johnny847]

I think the biggest reason to use mutual funds instead of ETFs, when we are talking about those from Vanguard (because as forummm said, Vanguard does some magic (which is actually patent protected until 2023, btw)...

If it's patent protected, then the magic is publicly available knowledge and we could look it up, so "magic" might not be an apt term.

The point of a patent is that a company discloses its invention in exchange for a monopoly over it for a fixed period.

If a company wants to keep its invention secret, it can do that too, but then it doesn't get a legally enforceable monopoly over it, which means if the secret gets out, there is no protection. This is referred to as a "trade secret" and is quite different from a patent. If you obtain or spread a trade secret without proper authorisation (i.e. you steal it), then you can be punished under various laws, but anybody who innocently learns about the secret is free to do whatever they want with it, because it's not patented.

If a company has some invention that it relies on, it has to make a decision whether to keep it as a trade secret, or to publicly disclose and patent it.

I didn't literally mean magic. I meant magic as in it seems magical to me. As in Vanguard is clever.

[Indexer]

Indexer - what is it that you see as the "common misconception"? 

I forget where I read it or if it is even accurate, but I read that with mutual funds, when they rebalance themselves, it is a taxable event for the fund owners. ETFs aren't taxed until they are sold (hopefully at cap gain rate) so the rebalancing event doesn't take place. That said, I don't know of an ETF that keeps an AA like the balanced fund, but might affect something like VT or VTI if they are balancing the caps?

The bolded section is the misconception.  People say all the time that ETFs are super tax efficient and not taxed until sold.  It is a common misconception.  [As a general rule]Index funds are very tax efficient and aren't taxed until sold.  Most ETFs are index funds so that is why it is true for most ETFs.  Its the word index that makes them tax efficient, not the ETF.  If you look at active ETFs like a lot of your leveraged/inverse ETFs they distribute capital gains quite often. 

Now in certain situations[mass redemptions] the index ETF will do even better than the index fund, but as a general rule it is the word index that makes something more tax efficient, not the ETF.

[PEIslander]

Thanks Indexer for the clarification --- I agree with what you wrote. In general investors don't really need to sweat if they are invested in index-tracking ETFs or Mutual Funds. It is the index tracking itself that is the biggest benefit.