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Selecting Indexed Mutual Fund vs. ETF
Old 08-20-2009, 02:02 PM   #1
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Selecting Indexed Mutual Fund vs. ETF

If this question has come up before, perhaps someone could point me to it.

I was just wondering how most people choose to invest in indexed funds - a mutual fund or an ETF. I know there are some tradeoffs - for example, at Vanguard, I can buy and sell Vanguard funds without a transaction fee, whereas the ETFs have transaction fees. Sometimes the expense ratios are a little lower on the ETFs, however.

Do most people calculate the difference in the expense ratio for the amount of $ they plan to invest, and determine which is more cost efficient? Or, do you just assume if you will be re-balancing that the mutual fund is more cost effective in the long run? Do you take other factors into consideration, such as the ability to buy/sell an ETF at a specified price throughout the day?

I'd appreciate any thoughts on this. Thanks.

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Old 08-20-2009, 02:33 PM   #2
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Vanguard makes it easy with a comparison calculator. Which is right for you depends and the calculator will help with that decision.


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Old 08-20-2009, 07:15 PM   #3
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Originally Posted by ksr View Post
Do you take other factors into consideration, such as the ability to buy/sell an ETF at a specified price throughout the day?
I'd appreciate any thoughts on this. Thanks.
Keep in mind that I might go with an index fund's lower expense ratio rather than with an ETF. But I've usually been able to find an ETF at a competitive expense ratio to its index-fund equivalent.

A couple other reasons to go with ETFs:
- The passive ETF won't deviate from its index. So far tracking error has been a good thing at Vanguard but I wonder how long Gus Sauter & team can keep up the magic. Just my personal bias, not trolling for a defense.
- No short-term trading fees or penalties. No idea if this is an issue at all fund companies.
- The ability to short and to trade options.

Another personal bias is that brokerages (trading ETFs) seem to be more customer-oriented than mutual-fund companies. When you sell a mutual fund you're selling it back to the company through their rules and their procedures. (If "fair value" is invoked then it's even at their price.) When you sell an ETF you're selling it to anyone else, with the brokerage's rules/procedures, and sometimes at your price (limit or options).

Every time I've had to bitch at a company about trading my shares it's been in regard to a mutual fund. Even when I've bitched at Fidelity (which we've used for nearly 25 years) it's been about their mutual funds and not about their ETFs or stocks. I've never had to bitch at a brokerage about an ETF trade.

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Old 08-20-2009, 07:34 PM   #4
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There are advantages to both.

Both have expense ratios. Usually the ETF has a lower expense ratio, but Vanguard admiral class shares also have a very low expense ratio.

ETFs sometimes require a commission to buy and sell, but if you use a no-commission broker then there are no commissions.

ETFs trade at a discount or premium to the NAV. This bothers some people. The open-end fund always trades at the NAV calculated at the end-of-day.

When trading ETFs you have the bid/ask spread which can often be more than a few years savings on the expense ratio. If you sell one ETF and buy another in a tax-loss-harvesting move, you can lose 0.5% or more. But if you exchange one open-end mutual fund for another, there are no bid/ask spreads and you get what you pay for.

Those are the obvious differences in costs, but if you reinvest dividends there may be more friction. With the fund, the dividends are reinvested at the NAV the same day they are distributed. With ETFs, the dividends are paid in cash to the brokerage which them buys additional shares for your account. When the brokerage buys, they decide the price they use. It could be good or to their advantage. I would not automatically reinvest dividends from bond ETFs because you don't have control over how much you pay for the reinvested shares. With a fund you don't have this problem.

I use ETFs for stocks and funds for fixed income. With the ETFs you can buy intraday and with limit orders. For me, this is big advantage because one can try to buy at a lower price than the close or sell at a higher price than the close. A minor advantage is that the prices for ETFs are available when the market closes and you don't have to wait until 6 pm for your funds to update.

With funds, there are often trading restrictions like you need to wait 60 days before doing an online transactions. No such problem with ETFs. This helps with tax-loss-harvesting. Also with ETFs, it's pretty trivial to find a similar, but "not substantially identical" ETF (e.g. VBR <> IJS, VWO <> EEM, VTI <> VV, etc.), so no hassles finding another fund for TLHing.
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