Reconsidering ETF Portfolio

[2B]

About 18 months ago when rebalancing I decided not to go to an (almost) all ETF portfolio. My reasons were relatively low volume and wide bid-ask spreads on some of the ETFs. Things seem to have changed so I might do a flip-flop.

The ETFs of interest are VTI (all market), VB (US small cap), VEU (world minus US) and VWO (emerging markets). These are all Vanguard ETFs and have lower expense ratios than even the Admiral shares when available. I calculated that it would save for my portfolio about $1,200 to $1,500 per year. That's not a big deal but it still comes down to reducing my investment expenses down to about 0.1%.

I know others have considered ETF portfolios and some have them. Any comments plus or minus?

 

[LOL!]

I use almost exclusively ETFs in my taxable portfolio and do not reinvest the dividends. In my tax-deferred portfolios I use mostly bond mutual funds where the dividends are automatically reinvested.

There is some excellent discussion on the costs associated with ETFs over on the bogleheads board. First, you have commissions. These are easily avoided by using a broker like WellsFargo. Second, you have the bid/ask spread. As you noted, this appears to have been diminished to about 1 cent for active ETFs like VTI, VEU, VWO and reduced to 2 to 4 cents for things like GWX. Third, you have the premium/discount to NAV. This latter cost bothers folks who are used to mutual funds, but I say you generally will get the premium/discount going and coming.

But what seems to really bother folks alot is whether they do a market order or a limit order. It is pretty clear that if you put in a market order before the market opens, that you generally get ripped off. So the solution is to not do that. Submit your orders after the market has been open for 30 minutes and use either a market order or a limit order depending on your personality and whether you care if the order must be filled right away or not. Sometimes I use a market order; sometimes I use a limit order. If you are using 5000 or more shares, then you probably want to break up the order into smaller transactions or use a limit order, but even with 5000 shares you will do OK.

I find that access to real-time Level II quotes is indispensable in setting my limit prices. I like to set my limit prices away from the current action and have the market come to me. Some folks call this market timing and are dead set against it.

With ETFs, tax-loss harvesting is easy to do, but some folks are worreid about losing $500 to $1000 while selling one position and buying a different ETF for replacement shares. A possible way to avoid that is to market time: sell your shares while the market is trending down (not up), and thus try to buy your replacement shares at a lower price than they were trading when you sold your first ETF. Or sell on a big UP day and patiently wait a day or two for the drop that will very likely occur.

Anyways, ETFs are the way to go for me, but I am very patient with my transactions, never in a hurry and just fine if "one got away".

 

[RonBoyd]

Again, I offer this as, at the least, a good introduction to ETFs:

ETF Trends — Keeping a grip on exchange traded funds (ETFs)

and their easy-to-read book:

iMoney: Profitable ETF Strategies for Every Investor (price search)

 

[ziggy29]

The ETFs of interest are VTI (all market), VB (US small cap), VEU (world minus US) and VWO (emerging markets). These are all Vanguard ETFs and have lower expense ratios than even the Admiral shares when available.

Keep in mind that VEU already holds about 20% in emerging markets. So unless you want more than 20% of your non-US exposure in emerging markets, you don't even need VWO if you own VEU. If you wanted to be able to have emerging markets as a separate asset class for rebalancing, you could use VEA (which tracks the EAFE index) rather than VEU and hold both VEA (developed) and VWO (emerging).

 

[brewer12345]

That's all fine and well, but make sure your ETF is not trading at a premium to NAV. Many of the bond ETFs are trading at a premium right now, which is surprising to me.

 

[SteveL]

On the equity side, I am entirely in ETF's for the reason you mention, expenses. I have a few additional funds to the ones you name. I will be adding some bond etf's later this year.

When doing AA, I generally place orders in the middle of the day when buying, and early in the trading day and week when selling. I make AA trades a couple of times a year.

Vanguard is a great co., but the funds seem more set up for those accumulating rather than those in the distribution phase of life. ETF's allow you more choice of when you sell.....

If you are accumulating via monthly averaging in, funds rather than etf's are the way to go.

 

[ziggy29]

If you are accumulating via monthly averaging in, funds rather than etf's are the way to go.

Agreed. In my 401K and in our Roth IRAs where we are regularly adding cash, we use funds. In my rollover IRA from a previous employer's 401K plan, I mostly use ETFs since no new money is being added.

 

[DblDoc]

On the equity side, I am entirely in ETF's for the reason you mention, expenses. I have a few additional funds to the ones you name. I will be adding some bond etf's later this year.

When doing AA, I generally place orders in the middle of the day when buying, and early in the trading day and week when selling. I make AA trades a couple of times a year.

Vanguard is a great co., but the funds seem more set up for those accumulating rather than those in the distribution phase of life. ETF's allow you more choice of when you sell.....

If you are accumulating via monthly averaging in, funds rather than etf's are the way to go.

It really depends on the amounts involved, commissions paid and how long you hold. Vanguard has a calculator that will help with this decision. I use ETF's in my taxable account as I save significantly over time compared to the corresponding MF.

DD

 

[Lsbcal]

Here is a source for premium/discount history: ETFConnect - Fund Quick Facts - Vanguard FTSE All-World ex-US ETF - VEU

I'm still trying to understand the gotchas on ETF's. Would appreciate insights particularily on premium/discounts. From the history for a fund like VBR (Vanguard Small Cap Value) you could easily loose or gain on the premium/discount front by maybe 0.4%. On 100k that's $400.

Also from Rick Ferri's The ETF Book:

If you are not in a hurry, here are three recommendations for trading ETFs. First, trade ETFs after 10:00 AM Eastern time and befoe 3:30 PM Eastern time. That places a 30-minute no-trade band around the opening and closing bell when spreads are higher. Second, trade on nonvolatile days when there is a stable intraday value. Third, check the futures and options markets if you are trading during a volatile period because the intraday value of an ETF is likely to be inaccurate.

 

[LOL!]

... you could easily loose or gain on the premium/discount front by maybe 0.4%. On 100k that's $400.

I ignore premium/discount on the equity ETFs that I use. I figure that sometimes I will buy at a discount and sell at a premium or any other combination and it will all probably come out as a wash.

The 0.4% you mentioned is miniscule compared to the choice you have when buying and selling versus the end-of-day NAV you would get with a standard mutual fund. Since you can buy/sell intraday, you can get a better or worse price than the end-of-day NAV. Even VTI has daily ranges of 3% very often. If you buy at the bottom of that 3% range, you overwhelm any consideration for premium/discount, bid/ask spread, and expense ratio costs. Another way to say this is that an ETF rarely closes near the high or low for the day (even though Friday was such a day).

But you must be careful because you can blow your entire annual cost savings of the ETF vs mutual fund with a single stupid transaction. For some folks, the knowledge that that can happen is too stressful and they avoid ETFs.

Here is a specific fer-instance; on Friday I bought several hundred shares of VTI and paid 44.45. If I had bought VTSMX, I probably would have paid closer to closing price of VTI which was 44.19. In other words, using the ETF cost me 0.6%. I hope to make that up when I sell VTI. On that day, I am planning sell VTI for 3% higher than its closing price although I guess I should be happy with anything greater than 0.6% higher than its closing price.

 

[brewer12345]

Like LOL, I ignore discoun/premium on equity ETFs. Premiums on bond ETFs seem to be persistent, so I mostly do not use them. Instead I will use closed end funds trading at a substantial discount, mutual funds, and individual issues.

 

[Nords]

I know others have considered ETF portfolios and some have them. Any comments plus or minus?

We've been mutual-fund-free for a couple years and don't miss them a bit.

It used to really chap my hide to watch Tweedy-Browne, arguably the Buffett of mutual funds, still let their funds swell to humongous bloated sizes before "closing" them. They'd also double in size yet the expense ratio would stay flat-- or even go up!

I don't see the issue with ETFs. If you're trading 500 shares or more then it's probably a waste of time to haggle over a few pennies a share. Some brokerages will even reinvest dividends for free, just like mutual funds. We trade around the middle of the week, middle/late day, with limit orders. But we don't trade often enough to make a big focus out of it.

Highly recommended. No reason to go back to mutual funds.

 

[Lsbcal]

...
I find that access to real-time Level II quotes is indispensable in setting my limit prices. I like to set my limit prices away from the current action and have the market come to me. Some folks call this market timing and are dead set against it. ...

LOL, I'm not really familiar with Level II quotes. Just have standard accounts at Schwab and Vanguard. Does Level II cover Vanguard ETF's? Could you expand on how you use them to set a limit price? I want my transactions to trigger on the same day I place the trade.

Couldn't one just set the limit price between bid/ask and hope for the best?

 

[LOL!]

Couldn't one just set the limit price between bid/ask and hope for the best?

You could do that.

With Level II quotes you see the depth of orders. For example, suppose you want to buy 5000 shares of VTI. If you get a simple real-time quote it might say ask is 44.52 x 500 which means the lowest asking price is 44.52 but only for 500 shares. If you submit a market order, you will get that 500 shares for 44.52, but what about your other 4500 shares? If the next in line ask is 44.83 x 1000 shares, then your next 1000 shares will be bought at 44.83, and so on. You have just paid way too much for 4500 shares.

However, if you saw that the best asking price was 44.52 x 10000 shares, then placing a market order for 5000 shares should get you the 44.52 price.

One can also see where programs are trading. These are usually "artifical" bids/asks set maybe 5 to 10 cents above and below the current best bid/ask quotes. These artificial bids are changed constantly so they are rarely filled. I think they are there to capture large market orders as I described above from naive investors.

I don't really use Level II quotes to set a limit price per se, but I do use them to decide whether a market order will rip me off or not.

Level II quotes are available for all stocks/ETFs that trade throughout the day. A Schwab brokerage account should give you free level II quotes.

 

[Lsbcal]

LOL, thanks for the example. I talked to Schwab and they require 30 trades/quarter to give you the Level II software for free. Or you could pay $30/qtr. Or you could have a large account with them. My main account is with Vanguard and I'm anticipating doing maybe 10 trades per year.

The Schwab trader I talked with seemed to think that Level II quotes were the tip of the iceberg showing and that maybe I'd be better going through them to fill a large order. Just thought I'd mention what he said. I'm just getting some thoughts together on this stuff and not yet ready to pull the trigger. But I will be adding some market timing money into the market in a few months after having done some extensive backtesting. From what I've seen the Vanguard trading screens might be subpar. Still the emphasis for me will be the buy-hold part of the portfolio so no flames please .

 

[LOL!]

I have also heard the claim that if you have a large order that you should get your broker to help you because they can see some action that you cannot even see with Level II quotes. That said, the one person who reported details on that seemed to have gotten "taken" by his broker in my opinion. I have certainly traded up to 5000 shares at a time without feeling any need for my broker's help, but I am watching real-time Level II quotes to feel comfortable doing this.

I get free Level II quotes from TDAmeritrade. I have an APEX-level account with them. Until I did some tax-loss-harvesting in Nov-Dec, 2008 I had placed 0 trades with them the previous 18 months. I use WellsFargo for my primary investment accounts (free trades, no commission on Vanguard funds). My holdings at Vanguard are almost all 100% fixed income and I do maybe 3 transactions a year in those accounts.

Vanguard is changing their brokerage stuff, so it has to get better.

 

[Animorph]

I usually limit a few pennies below the bid price for a buy or above the asking price for a sell. Normal volatility will usually send the price through the limit and make the transaction. You might look at the intraday price chart to see which way the price is moving. If it is pretty steady in one direction I might adjust the limit. For my $10k transactions I haven't had any problems with incomplete orders.

Most times I have a specific price in mind (like 10% below my last buy) and set the limit at that price. If i get that price, great. If not, great.

ETF's were nice near the bottom of last year when the market prices at the end of the day could be 5% higher than the low for the day. I could buy when I hit my trigger points and not have to wait for the end of the day and see if the prices would still be there for mutual funds.

 

[ESRBob]

Love this discussion as I have recently (via tax-loss selling) switched a big chunk of our mutual funds into ETFs.

But for me the biggest appeal was something not mentioned here: the elimination (too strong a word, but I don't have great data on this, instead at least for index ETFs maybe we can say the dramatic reduction?) of capital gains distributions on which you have to pay taxes every year.

Nothing chaps my derriere like getting huge taxable capgains distributions in funds which may have even lost money that year, and thinking about its being at least partially a result of people who panic-sold my fund and forced the manager to sell good profitable investments to fund redemptions. End of year, those sales mean capgains for the remaining fund shareholders (if they net positive for the fund) which means I pay tax now instead of years from now or never (in my lifetime).

So when you sell ETF shares they just trade to the buyer. If there are too many or too few ETF shares available to match demand in the market, the approved agents can bring the required basket of securities to the ETF issuer at any time and get new ETF shares issued, or bring ETF shares to them and get the underlying securities delivered to them, any time. Again, no taxable capgains for other shareholders arising from this transaction. (This activity helps keep premiums and discounts in a manageable range). None of these cases trigger capital gains to the 'other shareholders' of the ETF -- just to the person selling if there is a gain in his or her shares sold.

So for long term buy-and-holders this I think turns out to be a big tax advantage over time.

Am still getting my arms around all this, but this is what my research has uncovered -- if I'm misunderstanding any of this, someone pls set the record straight.

 

[Nords]

But for me the biggest appeal was something not mentioned here: the elimination (too strong a word, but I don't have great data on this, instead at least for index ETFs maybe we can say the dramatic reduction?) of capital gains distributions on which you have to pay taxes every year.
So for long term buy-and-holders this I think turns out to be a big tax advantage over time.
Am still getting my arms around all this, but this is what my research has uncovered -- if I'm misunderstanding any of this, someone pls set the record straight.

Good point. I think ETFs give us personal control over our turnover ratio without having to worry what management (active or passive) is going to do to us.

There's also none of that year-end worry over whether or not to buy around an impending cap gains distribution...

 

[LOL!]

For the record, a few ETFs have paid cap gains distributions. For instance in Dec 2007, GWX paid cap gains distribution of about 3% of the asset value. It is true that most of the index ETFs that one should probably be investing in should have no cap gains distributions, but that also goes for index mutual funds.

There is still the year-end worry of buying the dividend.

 

[2B]

Last week I completed my conversion from mutual funds to ETFs in my IRA account. That account has most of my assets. The two Roths and DW's IRA are all in VTSMX. My taxable account has all VTI and 300 pathetic shares of BAC.

Here's what the conversion did as far as fees go.

DODFX (0.65%) became VEA (0.12%)
VEIEX (0.37%) became VWO (0.25%)
VTSMX (0.15%) became VTI (0.07%)
VSMAX (0.13%) became VB (0.10%)

It went very smoothly. With a CD recently matured, I had some free cash in my account. I bought about 2 to 2:30 every day and sold the nominal equivalent amount of mutual funds at the close. The next day ETrade had the cash available for investment so I did it again and again until I was done.

I paid $80 in commissions. I pay $5 for "market" and $10 for "limit." Most but not all of my ETF buys were limit orders. I break even in less than a month.

I also rebalanced my equities to the nearest 100 shares. All of my rebalancing is done in this account and I've moved the rebalancing date to early January since all the funds except VTI pays dividends on Dec 31. VTI does it quarterly.

My IRA also has all my CDs which is most of my fixed income/cash stuff. Getting the dividends in cash makes it easier to rebalance. My other tax deferred accounts all reinvest their dividends.

 

[Marcretire]

Here is a source for premium/discount history: ETFConnect - Fund Quick Facts - Vanguard FTSE All-World ex-US ETF - VEU

I'm still trying to understand the gotchas on ETF's. Would appreciate insights particularily on premium/discounts. From the history for a fund like VBR (Vanguard Small Cap Value) you could easily loose or gain on the premium/discount front by maybe 0.4%. On 100k that's $400.

Also from Rick Ferri's The ETF Book:

One gotcha that has kept me away from ETFs,at least in my taxable acct, is that you pay a commission on each transaction. If you dollar cost average, as I do, those commissions add up and detract from your returns, esp. over time.

 

[LOL!]

DODFX (0.65%) became VEA (0.12%)
VEIEX (0.37%) became VWO (0.25%)
VTSMX (0.15%) became VTI (0.07%)
VSMAX (0.13%) became VB (0.10%)
...
I paid $80 in commissions. I pay $5 for "market" and $10 for "limit." Most but not all of my ETF buys were limit orders. I break even in less than a month.

2B, you have done what you've done, so this note is mostly for others watching this.

(1) A better match for DODFX is VEU since both contain emerging markets equities in about the same proportion.

(2) Your Vanguard switches are merely a different share class of the same fund. Vanguard would've let you change share class at the NAV for $50 per switch. I think you sold the fund at NAV then purchased the ETF shares the next day, so that means there was some friction there. If the fund dropped in value over that day, you made money. If it gained in value, then you lost money. It's not clear where you held your Vanguard funds and thus the costs to do these exchanges.

You stated this was in your IRA, so no tax-loss harvesting, but for others these transactions of converting from the investor share class to the ETF share class could be so-called wash sales if the shares were sold for a loss.

 

[2B]

2B, you have done what you've done, so this note is mostly for others watching this.

(1) A better match for DODFX is VEU since both contain emerging markets equities in about the same proportion.

(2) Your Vanguard switches are merely a different share class of the same fund. Vanguard would've let you change share class at the NAV for $50 per switch. I think you sold the fund at NAV then purchased the ETF shares the next day, so that means there was some friction there. If the fund dropped in value over that day, you made money. If it gained in value, then you lost money. It's not clear where you held your Vanguard funds and thus the costs to do these exchanges.

I intended to get VEA because my emerging markets are "pure" in VWO. Because of the CD cash, I bought the ETF shortly before the close and sold the mutual fund on the close. The time difference was within an hour. Being anal, I kept a rough track of how things worked out between where the market closed and what I bought the ETF for. I was slightly ahead but not too much overall.

The IRA was at Etrade so I got off much cheaper than if I paid Vanguard $50 for each swap.

I have VTI in my taxable account but don't reinvest dividends. I'm more than keeping my AA in equities by my 401k and SERP contributions.

 

[Lsbcal]

...
(2) Your Vanguard switches are merely a different share class of the same fund. Vanguard would've let you change share class at the NAV for $50 per switch. I think you sold the fund at NAV then purchased the ETF shares the next day, so that means there was some friction there....

LOL, are you saying here that VG will let you switch from ETF's to funds and vice-versa at the closing day price of the fund (the NAV) for $50? So especially if the ETF is selling at a premium you will perhaps get a better deal depending on the trade amount. An observation, Rick Ferri has suggested buying/selling ETF's one-half hour before close (or after the open) so I guess this would be counter to his suggestion.