ETF vs Mutual Funds

[Steel Rain]

OK, im zeroing in on my asset allocation plan and am now at the part where i need to choose specific investments. During one of my other questions, someone posted that there were concerns surrounding ETFs. Aside from vague articles on things like liquidity, can someone provide some thoughts on why someone should do Mutual funds vs ETFs? My plan is to be in mostly index stuff, so im not intersted in managed funds. Costs are very low for things like SPY and DIA, but vanguard funds are almost the same. Thanks.

Kevin;

 

[samclem]

With Vanguard the internal costs are (usually) very close to the same overall. If you are buying small amounts frequently and you don't get free trades through your brokerage, then MFs will be cheaper than buying ETFs.


This recent thread might be of interest to you. Note that the internal expenses and trading fees (commissions), and the bid/ask spread for ETF's aren't the only things to be aware of. ETFs trade at either a discount or a premium to the underlying value of the stocks (NAV) they contain. These premiums/discounts vary all the time, but can can stay on the same side of the NAV line for months (i.e. the ETF could be trading at a premium or a discount for a long time). If you buy shares on one side of the "line" and sell on the other side, you can gain/lose up to 1 percent (typically) of your investment compared to a straight mutual fund purchase/sale.

Also, during the recent "flash crash," some ETFs lost more than 90% of their value even though the stocks they contained had not changed their value appreciably. It only lasted for a very short time (less than a minute IIRC) and was a result of lots of automated trading and a computer glitch or two. I think most of the trades were later cancelled, but it's a little scary nonetheless and highlighted (at least to me) some important differences between these products and a conventional open-end mutual fund. If you go with ETFs it might be best to avoid automatic sell/buy orders just to avoid getting burned if this happens again.

I don't own any ETFs, but I would buy them if there was a particular asset class I wanted that I couldn't adequately cover with low-cost MFs.

 

[rayvt]

ETFs tend to have lower expense ratios. There is no minimum investment size, no minimum holding period requirment. But you have to pay a brokerage commission.

 

[Steel Rain]

With Vanguard the internal costs are (usually) very close to the same overall. If you are buying small amounts frequently and you don't get free trades through your brokerage, then MFs will be cheaper than buying ETFs.


This recent thread might be of interest to you. Note that the internal expenses and trading fees (commissions), and the bid/ask spread for ETF's aren't the only things to be aware of. ETFs trade at either a discount or a premium to the underlying value of the stocks (NAV) they contain. These premiums/discounts vary all the time, but can can stay on the same side of the NAV line for months (i.e. the ETF could be trading at a premium or a discount for a long time). If you buy shares on one side of the "line" and sell on the other side, you can gain/lose up to 1 percent (typically) of your investment compared to a straight mutual fund purchase/sale.

Also, during the recent "flash crash," some ETFs lost more than 90% of their value even though the stocks they contained had not changed their value appreciably. It only lasted for a very short time (less than a minute IIRC) and was a result of lots of automated trading and a computer glitch or two. I think most of the trades were later cancelled, but it's a little scary nonetheless and highlighted (at least to me) some important differences between these products and a conventional open-end mutual fund. If you go with ETFs it might be best to avoid automatic sell/buy orders just to avoid getting burned if this happens again.

I don't own any ETFs, but I would buy them if there was a particular asset class I wanted that I couldn't adequately cover with low-cost MFs.

Hmm, good thread. Im a TD ameritrade customer and will buying once per month in the 4k range, so the cost very low. I plan to buy and hold, doing rebalancing via contributions so the bid ask spread is not really too much of an issue. However, I may split the difference, there are a lot of very low cost vanguard funds that are only a few hundreths of a percent higher than ETFs, so I will probably buy some of them.

The big savings come in the international area it seems, not sure why that is and its a little worrying actually.

Kevin;

 

[MichaelB]

TD Ameritrade has some no transaction fee ETFs. This may be an advantage. Passive ETFs in taxable accounts have an advantage in that they are likely to be more tax efficient than mutual funds because they should have less (or no) capital gains, especially if they have been operating for a couple of years.
ETFs that transact large volumes, such as SPY, will not see much discount or premium, so that should not be a worry.

When you say "the big savings come in international funds", what do you refer to? Expense ratios of Int'l ETFs vs mutual funds?

 

[Steel Rain]

TD Ameritrade has some no transaction fee ETFs. This may be an advantage. Passive ETFs in taxable accounts have an advantage in that they are likely to be more tax efficient than mutual funds because they should have less (or no) capital gains, especially if they have been operating for a couple of years.
ETFs that transact large volumes, such as SPY, will not see much discount or premium, so that should not be a worry.

When you say "the big savings come in international funds", what do you refer to? Expense ratios of Int'l ETFs vs mutual funds?

Tax advantage is important since these will be in a taxable account. 60 mins of research, not much i agree, seems to show that ETFs for international equities, particularly emerging market ETFs are quite a bit cheaper than mutual funds, but my sample size is still pretty small.

Steel

 

[LOL!]

Also, during the recent "flash crash," some ETFs lost more than 90% of their value even though the stocks they contained had not changed their value appreciably. It only lasted for a very short time (less than a minute IIRC) and was a result of lots of automated trading and a computer glitch or two. I think most of the trades were later cancelled, but it's a little scary nonetheless and highlighted (at least to me) some important differences between these products and a conventional open-end mutual fund. If you go with ETFs it might be best to avoid automatic sell/buy orders just to avoid getting burned if this happens again.

This is a big advantage for ETFs if you are a buyer. I was able to buy shares at 10% below the closing price that day.

ETFs are for folks who have time to submit orders when the market is open and are not bothered by figuring out the price they want to pay. Sure, one can do a market order but many folks would recommend a limit order so that one is not taken advantage of. On the bogleheads forum, quite a lot of folks cannot figure out a limit price, so they prefer mutual funds.

Mutual funds are for folks who want simplicity and like to submit orders when the market is closed. You are guaranteed to get the next available NAV and not get ripped off. Also if you are buying $500 worth, you get $500 worth with whatever fractional shares that might be. With ETFs you have to buy integral number of shares.

As for expense ratios, ETFs and mutual funds nowadays have the same expense ratios ... as long as you are buying something like Admiral or Signal share class from Vanguard.

Commissions are really a thing of the past. One should use a broker that doesn't charge a commission. WellsFargo has no commissions, while Fidelity, Vanguard, TDAmeritrade, Scottrade, et al have no commissions on select products.

 

[MichaelB]

Tax advantage is important since these will be in a taxable account. 60 mins of research, not much i agree, seems to show that ETFs for international equities, particularly emerging market ETFs are quite a bit cheaper than mutual funds, but my sample size is still pretty small.

Steel

In a taxable account ETFs have a clear advantage over mutual funds because of the reduced or non-existent capital gains distributions. Int'l ETFs expense ratios could be lower for a number of reasons. Buying and selling stocks around the world is more expensive than here in the US, so transaction costs are much higher. The ETFs are generally passive, so little trading cost. There is considerable competition between ETFs, and because they are passive, there is no reason for expense ratios to be high.

Because they are in taxable accounts, be sure to look at the QDI for the int'l funds before buying. There are significant differences among them, even for similar markets.

 

[KiraC]

Here's a good explanation of the differences of ETF's and Mutual Funds.

IMO, there are too many holding restrictions and penalties with mutual funds if you need to cash them out so I will never buy another mutual fund. I frequently trade and hold ETF's.

 

[sengsational]

Mutual funds are 'easier' with respect to pricing.. they are a no-brainer. But I've been moving into more ETF's lately. Not real comforable with the buying and selling, though. I wondered about if you stand a better chance of getting a good price if you order round lots. My last purchase, I had enough cash to get only 1950 shares, so I put in an order with a price that would get me 2000, and forgot about it. A few days later the order ended up getting filled. Luckily it wasn't the "catching a falling knife" scenario, just a little dip. I've seen only a few ETF orders myself, so not used to getting he edge. How does one figure if the ETF price is in line with the underlying stock? Seems like by the time you calculate it, the prices would all have changed!

 

[sengsational]

Here's a good explanation of the differences of ETF's and Mutual Funds.

IMO, there are too many holding restrictions and penalties with mutual funds if you need to cash them out so I will never buy another mutual fund. I frequently trade and hold ETF's.

I've aways looked at the holding restrictions as a benifit to me; since I'm not a frequent trader, I'm not impacted, and the rules keep the expenses for the other holders down.

That brings up a point about ETF's. What keeps people from doing that kind of 'harmful trading' that MF's restrict? If there were commissions, I can see how that would control it, but earlier in the thread, folks were saying ETF buyers were not paying commissions, in some conditions.

 

[pb4uski]

I've aways looked at the holding restrictions as a benifit to me; since I'm not a frequent trader, I'm not impacted, and the rules keep the expenses for the other holders down.

That brings up a point about ETF's. What keeps people from doing that kind of 'harmful trading' that MF's restrict? If there were commissions, I can see how that would control it, but earlier in the thread, folks were saying ETF buyers were not paying commissions, in some conditions.

But the trading of ETFs isn't harmful because trading doesn't cause the fund itself to have to sell or buy the underlying investments like it does in the case of mutual fund transactions. When ETF's are traded, it is just between different ETF holders and has no effect on the operation of the fund since there is no change in the number of ETFs outstanding.

 

[sengsational]

But the trading of ETFs isn't harmful because trading doesn't cause the fund itself to have to sell or buy the underlying investments like it does in the case of mutual fund transactions. When ETF's are traded, it is just between different ETF holders and has no effect on the operation of the fund since there is no change in the number of ETFs outstanding.

Yeah, I agree with that. It just seemed like something had to "give". But we might be on to something with respect to my other question:

.How does one figure if the ETF price is in line with the underlying stock? Seems like by the time you calculate it, the prices would all have changed!

Seems like if you made sure the price was in-line with the underlying stock value when you buy, you'd be ok, but let's say there's some folks out there that monitor this difference between the ETF price and value of the stocks that make-up the ETF. When the ETF price has momentum heading above the stock price, they do a quick purchase, and then sell as the momentum dissipates. If the buy and hold guy happens to buy at that time, s/he pays too much?

--Dale--

 

[LOL!]

If the ETF has sufficient volume, so that buyers and sellers are active and trades are occuring every minute or less, then I do not believe one has to worry. The exchanges are supposed to publish the intraday indicative value (google that) which one can get a quote for, but I wouldn't trust that number anyways.

So do not use ETFs that trade less than about 50,000 shares a day. I know some folks won't like that statement.