Index Funds Pros and Cons

[ats5g]

I don't see the real benefits to using ETF's in a tax efficient asset class like large caps. Morningstar shows that VFINX is more tax efficient than SPY. That coupled with no transaction costs if bought directly from Vanguard, doesn't bode well for SPY. Of course, if one can get admiral shares [VFIAX] then SPY looks even worse.

For tax inefficient asset classes like SCV and SC, I can understand going with an ETF over and index fund, say IJS or IWN over VISVX.

Bernstein wrote and article on this issue: The ETF vs. Open-End Index-Fund Shootout

- Alec

[bpp]

Originally Posted by ats5g

I don't see the real benefits to using ETF's in a tax efficient asset class like large caps. Morningstar shows that VFINX is more tax efficient than SPY. That coupled with no transaction costs if bought directly from Vanguard, doesn't bode well for SPY. Of course, if one can get admiral shares [VFIAX] then SPY looks even worse.

There are better ETFs than SPY. SPY was one of the first, and later ones improved on its design. I forget the details, but I think that the way SPY handles dividends leads to a lot of cash drag, for example.

To really compare apples to apples, how would you come down between VTI and VTSMX? My calculations showed some cost advantage to VTI, even given the bid-ask spread, if one makes one or two big purchases per year. Particularly if one cannot buy directly from Vanguard, and is faced with a big commission to buy VTSMX. For monthly DCA, though, VTSMX is likely better.

[ats5g]

Originally Posted by bpp

There are better ETFs than SPY.* SPY was one of the first, and later ones improved on its design.* I forget the details, but I think that the way SPY handles dividends leads to a lot of cash drag, for example.

To really compare apples to apples, how would you come down between VTI and VTSMX?* My calculations showed some cost advantage to VTI, even given the bid-ask spread, if one makes one or two big purchases per year.* Particularly if one cannot buy directly from Vanguard, and is faced with a big commission to buy VTSMX.* For monthly DCA, though, VTSMX is likely better.

Excellent points Bpp. I was poking around Vanguard's website and found something I had almost forgotten:

Can I convert conventional Vanguard mutual fund shares to Vanguard ETFs?

Shareholders of Vanguard index funds that offer Vanguard ETFs may convert their conventional shares to Vanguard ETFs of the same fund. This conversion is generally tax-free, although some brokerage firms may be unable to convert fractional shares, which could result in a modest taxable gain.

Vanguard will charge $50 for each conversion. (This fee is waived for Flagship clients.) Your brokerage provider may charge an additional fee for this service. For more information, contact your brokerage firm, or call 866-499-8473.

Once you convert to Vanguard ETFs, you cannot convert back to conventional shares. Also, conventional shares held through a 401(k) account cannot be converted to Vanguard ETFs.

- Alec

[ats5g]

This doesn't apply to Vanguard VIPERS, but I thought I'd post it anyway:

Qualifying Dividends: ETF's vs Index Funds

The ETF creation-redemption mechanism which provides for the vehicle’s capital gains tax efficiency has a corresponding negative impact on the vehicle’s efficiency at realizing qualifying dividends, which are taxed at lower tax rates. Regulations require that shares meet holding period requirements (for both sales and purchases of shares around the dividend distribution date) to qualify for the tax preference. Institutional ETF creation-redemptions often violate these holding period requirements, generally resulting in lower dividend tax efficiency for an ETF in comparison with a similar Index Mutual Fund. Both ETFs and Index funds can apply non-qualifying dividend income for expenses, leaving the maximum amount of qualifying dividends for distribution to shareholders.

See corresponding table.

- Alec

[FinanceDude]

Well.................someone's buying ETF's..................they're about 40% of the volume on the AMEX............

[Nords]

Originally Posted by FinanceDude

Well.................someone's buying ETF's..................they're about 40% of the volume on the AMEX............

I bet it's mutual funds... it makes window-dressing so much easier!

[FinanceDude]

Originally Posted by Nords

I bet it's mutual funds... it makes window-dressing so much easier!

So, in the eyes of the Vanguard die-hards, ETF's have no place in the investing world

[Nords]

Originally Posted by FinanceDude

So, in the eyes of the Vanguard die-hards, ETF's have no place in the investing world

One of the lesser reasons I don't visit that board (Hokus being the main reason) is the relentless zealots who won't consider anything that's not a Vanguard mutual fund. They kinda overlook Taylor Larimore's admonition that "there are many roads to Dublin"...

[mickeyd]

relentless zealots who won't consider anything that's not a Vanguard mutual fund.

Not sure that I agree with you a 100% Nords. They, naturally, bend over to validate Vanguard funds (as you would expect), however I have seen many occasions when other funds (FIDO, TRP, TIAA-CREF, American Funds to name a few) are given positive cudos for their products and service.

[ats5g]

Originally Posted by FinanceDude

So, in the eyes of the Vanguard die-hards, ETF's have no place in the investing world

I wouldn't say that. Being a diehard, I'd think many of them would agree w/ Vanguard on that subject:

Vanguard ETFs can benefit …

- Long-term, buy-and-hold investors. Because buy-and-hold investors don't incur frequent trading costs, they can reap the benefit of the lower expense ratios characteristic of Vanguard ETFs.* * *

- Investors with a sizable lump-sum amount to invest. A single large investment spreads the trading commissions across the entire investment, reducing the impact of the fees. In the long term, Vanguard ETFs' lower expense ratios can make up for the initial transaction cost.

- Investors looking for the trading flexibility of stocks. Vanguard ETFs can be bought or sold from a broker at any time during the trading day, allowing investors to use stock trading techniques such as limit orders, buying on margin, and selling short.*

Traditional index funds can be better for …

- Investors who rebalance frequently. When you rebalance, you have to go through a broker to buy or sell Vanguard ETFs holdings and incur commissions and bid-ask spreads. These fees will reduce the cost benefit of your ETF investment.

- Investors engaging in regular transactions. If you practice dollar-cost averaging,** make direct deposits or periodic withdrawals, buying and selling Vanguard ETFs will generate brokerage commissions to complete the transactions. These fees will erode the cost benefit of your investment.

- Investors with a small amount to invest. There are no trading commissions from Vanguard when you purchase our traditional index funds directly from us. Because you buy Vanguard ETFs through a broker, you will typically incur commissions and bid-ask spreads. It will be difficult for Vanguard ETFs' lower expense ratios to make up for the initial transaction costs of small investments—even in the long term.

There are certainly some diehards that use ETF's for LV, MV, SC, SV, and micros.

- Alec

[Nords]

Originally Posted by mickeyd

Not sure that I agree with you a 100% Nords. They, naturally, bend over to validate Vanguard funds (as you would expect), however I have seen many occasions when other funds (FIDO, TRP, TIAA-CREF, American Funds to name a few) are given positive cudos for their products and service.

Didn't mean to give a wrong impression that they're all relentless zealots, but those humorless few sure make it a less pleasant place to participate...

[ats5g]

Originally Posted by Nords

Didn't mean to give a wrong impression that they're all relentless zealots, but those humorless few sure make it a less pleasant place to participate...

Thank God M* put in that "ignore poster function". Makes post with H**** in them much, much shorter.*

- Alec