Why ETFs?

[BOBOT]

I have a couple of etfs because I wanted targeted index exposure to specific areas of the globe & couldn't find it in the mutual fund offerings - at least not at VG.

Other than that sort of consideration I don't understand the attraction of index etf's compared to their mf counterparts. If a total stock index etf, for example, and mutual fund have essentially the same portfolio and expense ratio, why would a buy-and-holder opt for the etf? I've read that the drag on mf's from frequent trading are passed to the remaining shareholders whereas with etf's they're borne by the trader, but many or most index mf's have a restriction on frequent trading anyway, so I don't know how that's a problem.

ANyway, why would you opt for an broad index etf over a comparable mutual fund?

 

[GalaxyBoy]

Bogleheads wiki article:

https://www.bogleheads.org/wiki/ETFs_vs_mutual_funds

Expense ratios of ETFs are generally lower, except VG Admiral Shares. I have my accounts at Schwab were Admiral Shares are not available.

Trading costs can be lower for ETFs. When I was w*rking I had a self-directed brokerage account as part of my 401(k). Mutual funds cost $49 per trade while stocks or ETFs only cost $9. Since the choices of funds in the basic account stank, I bought VG ETFs about once a quarter.

Many ETFs pay out much less or no capital gains distributions making those more tax-efficient than their MF counterparts (if held in taxable accounts).

 

[MichaelB]

In taxable accounts ETFs are - or can be - much more tax efficient. Mutual funds must declare and distribute capital gains, while ETFs can accrue them.

 

[easysurfer]

Made me do a search as I have the same question.

Here's a comparison from Investopedia:

Exchange-traded funds (ETFs) have become increasingly popular since its inception in 1993. But despite investor's love affair with ETFs, a closer look shows that index funds are still the top choice for the majority of retail index investors. Here we will look at the reasons why ETFs have become so popular and analyze whether they make sense - from a cost, size and time-horizon standpoint - as an alternative to index funds. (See also: Introduction to Exchange-Traded Funds and The Lowdown on Index Funds)

As with many financial decisions, determining which investment vehicle to commit to comes down to "dollars and cents." Given the comparison of costs, the average passive retail investor will decide to go with index funds. For these investors, keeping it simple can be the best policy. Passive institutional investors and active traders, on the other hand, will likely be swayed by qualitative factors in making their decision. Be sure you know where you stand before you commit.

ETFs Vs. Index Funds: Quantifying The Differences

I've been investing passively in index funds before ETFs were cool, and plan on continuing that way .

 

[LOL!]

ANyway, why would you opt for an broad index etf over a comparable mutual fund?

If one likes Vanguard products, but not the Vanguard web site nor the sometimes archaic poor service of Vanguard, then one can use Vanguard ETFs at other financial institutions that have superb service and great web sites. It is usually more costly to use Vanguard mutual funds at non-Vanguard places.

Now I will admit that people who have only used Vanguard and its web site often don't know that the grass can be greener on the other side ... especially if one takes the green-grass of Vanguard ETFs with them.

And for the buy-and-hold person, if there is no difference between the fund and the ETF, then there is no penalty for using the ETF in the first place, but there is an advantage if you get pissed off with your broker because you can pick up your toys and go somewhere else very easily.

 

[OldShooter]

I think they are almost equivalent, but there is a gotcha in the ETFs' fine print --the "authorized participant."

Do a little reading. These are unaffiliated third parties on whom EFTs rely for liquidity. In normal trading, this little arbitrage thing seems to work fine. When the market is tanking (think 10/19/87) are the authorized participants going to be buying shares and taking near-certain losses or are they going to be sitting on the sidelines while EFT share plunge due to lack of liquidity? Or, worse, will some of them get wiped out and be unable to settle their trades?

This is kind of a theoretical risk, I understand, but since I am a buy and hold guy with almost everything in tax-sheltered accounts there is no allure in worrying about commissions, spreads, intra-day trading, or the behavior of authorized participants.

Pet peeve/different subject: I am amazed by people, even professionals, who equate "ETF" with "Index Fund." An ETF may have either an active strategy or a passive one. Worse, even ones with "index" in their names are often sector funds -- wolves in sheeps' clothing IMO.

 

[Gotadimple]

+1 on ". . . wolves in sheeps' clothing. . ."
That said, if you like index investing and the ETF is an index that follows the same benchmark as an index mutual fund, pick the ETF for lower ER, fewer distributions, and greater liquidity. There are many true index ETFs (meaning major benchmarks, not something the brokerage cooked up) that are no-fee/low-fee at many brokers.

As for the active ETFs - I'm leary, again, because there is a basis on some benchmark that may not be broadly followed. These are just specialty funds IMO.

 

[OldShooter]

... These are just specialty funds IMO.

Exactly. People buying these and believing that they are "passive" or "index" investors have drunk the wrong kool-aid IMO.

All the academic work on passive investing is based on owning "the market." i.e., everything. S&P SPIVA has shown us that the work is still valid when "the market" is broken into large sectors, but IMO the smaller the sector the more the buyer is effectively stock-picking and we all know how that turns out.

 

[JoeWras]

Taxes are the big thing. I like donating appreciated securities. Since MFs throw off gains, it is hard to let that gain build up so you can donate it away. (Just one of many examples.)

OldShooter above mentioned the liquidity agents. It might be interesting to see there were some issues with this in recent "flash crashes," although I think some changes have been made to ETFs to help avoid the value getting too out of kilter.

 

[MRG]

Don't forget the difference on settlement. ETFs are T+3, funds are T.

 

[UnrealizedPotential]

I was wondering the same thing some months ago for my former 401k. I have both ETF's and mutual funds. Fees can sometimes be lower with ETF's and they can be traded during the day, unlike mutual funds which cannot. I ended up going with a mutual fund since the fees were already low since I put it in an index fund.

I would say both are fine, but sometimes like it has been mentioned fees can sometimes be lower in an ETF. There is not too much advantage to being able to trade during the day with an ETF if one is a long term investor.

So I invest in both, I like them both. They just function a little differently, that's all.

Edit to add:ETF's don't have the capital gains headache at the end of the year. If it's in a tax deferred account, then it doesn't matter.

 

[LOL!]

... When the market is tanking (think 10/19/87) are the authorized participants going to be buying shares and taking near-certain losses or are they going to be sitting on the sidelines while EFT [sic] share plunge due to lack of liquidity?

Pet peeve/different subject: I am amazed by people, even professionals, who equate "ETF" with "Index Fund."

Well, sure, one has to do their own due diligence with both ETFs and mutual funds. I'll give an example:
Is Fidelity Total Bond Fund (FTBFX) an index fund or an actively-managed fund?

Personally, I like that ETF shares plunge due to lack of liquidity. I can provide the liquidity and buy shares at 10% to 50% discount. I don't think you can do that with a mutual fund. Unfortunately, it only happens about once every 10 years or so. And sometimes the trades get busted.

 

[RunningBum]

If there's no real advantage to a mutual fund over the equivalent ETF, why NOT an ETF? If you don't care about one of the few differences, and the expense fees are the same, it's like asking why anyone would pick heads over tails, isn't it?

Question, if one converts Vanguard funds to the equivalent Vanguard ETF, can you still sell by Spec ID from when the mutual funds were purchased? For example, say 10 years ago I bought a fund and it has doubled in price, and a year ago I bought a bunch of new shares and it's been flat in the last year. If I convert to an ETF, and then want to sell some shares, can I still pick out those shares with no gain?

 

[OldShooter]

Well, sure, one has to do their own due diligence with both ETFs and mutual funds.

Agreed. How many do not? I think it's a significant number. Certainly the hucksters believe that the unwary constitute a market.

Is Fidelity Total Bond Fund (FTBFX) an index fund or an actively-managed fund?

To me the issue is even more fundamental: The whole idea of a bond index fund seems flawed. With stocks, you have a fairly limited universe where with bonds it is huge. So indices that claim to track the same segment might not even track each other. Also, AFIK the basic academic work in passive investing is all based on equities, so its applicability to fixed income is uncertain. But I have no interest in bond funds anyway so the question doesn't bother me too much.

Personally, I like that ETF shares plunge due to lack of liquidity. I can provide the liquidity and buy shares at 10% to 50% discount. I don't think you can do that with a mutual fund. Unfortunately, it only happens about once every 10 years or so. And sometimes the trades get busted.

Yup. You're a trader. I just want clocks and markets that are reliable and that follow the rules 100% of the time. As a practical matter I wouldn't be trading in a chaotic market anyway so what happens to EFT sellers when liquidity disappears is almost a spectator sport. Not quite, though, because when the excrement hits the ventilating device it has a tendency to get on everyone.

 

[Blue Collar Guy]

In taxable accounts ETFs are - or can be - much more tax efficient. Mutual funds must declare and distribute capital gains, while ETFs can accrue them.

As usual I know zero about this issue stated above, but I already have Vanguards Admiral funds so I have the lower fee schedule. I dont do anything on vanguards website other than look at the balances. I have a nice lady assigned to me as a customer service person, she either answers the phone or calls me back and she does the changes over the phone.

 

[BOBOT]

In taxable accounts ETFs are - or can be - much more tax efficient. Mutual funds must declare and distribute capital gains, while ETFs can accrue them.

Yes, one good reason; thanks.

 

[BOBOT]

.......
Question, if one converts Vanguard funds to the equivalent Vanguard ETF, can you still sell by Spec ID from when the mutual funds were purchased? For example, say 10 years ago I bought a fund and it has doubled in price, and a year ago I bought a bunch of new shares and it's been flat in the last year. If I convert to an ETF, and then want to sell some shares, can I still pick out those shares with no gain?

I would think it would depend on your cost basis election. If you had elected average cost basis (for accounting simplicity) then I would think not; if you picked specific lot id than I would think yes.

 

[jim584672]

ETFs are better...

Intraday trading
Possibly lower expense ratios
Possibly lower distributions
No restriction on number of trades*

*With any normal broker, Vanguard brokerage tries to make this an issue for no reason.

Downsides...
Possible difference between price paid and NAV
Commission (sometimes)
Whole shares only, no fractions
Bid / ask spread

 

[RunningBum]

I would think it would depend on your cost basis election. If you had elected average cost basis (for accounting simplicity) then I would think not; if you picked specific lot id than I would think yes.

Since I asked "can you still sell by Spec ID" it's pretty clear I have elected spec ID. And I'd like to hear a more definitive answer than "I would think" but I guess I have to call VG anyway to do the transfer so I can ask them and hope I get someone who really knows.

 

[jim584672]

Don't forget the difference on settlement. ETFs are T+3, funds are T.

Just a note- starting September 5th T+2 becomes the new settlement period.

 

[youbet]

In taxable accounts ETFs are - or can be - much more tax efficient. Mutual funds must declare and distribute capital gains, while ETFs can accrue them.

Of all the differences, that's the one that calls out to me......... I have one taxable account that, if all goes according to plan, is the bulk of my son's inheritance. At my death the accrued CG's on the ETF's will disappear as the basis is adjusted to that day's value. With MF's I'd be paying tax on the CG's every year because, as your say, MF's must distribute them.

 

[youbet]

but there is an advantage if you get pissed off with your broker because you can pick up your toys and go somewhere else very easily.

Yeah, being able to transfer from one brokerage to another "in kind" can be a huge advantage. Of course, many MF's will transfer in kind too, but not all.

 

[bingybear]

Of all the differences, that's the one that calls out to me......... I have one taxable account that, if all goes according to plan, is the bulk of my son's inheritance. At my death the accrued CG's on the ETF's will disappear as the basis is adjusted to that day's value. With MF's I'd be paying tax on the CG's every year because, as your say, MF's must distribute them.

MF has to pay realized capital gains, not all unrealized gains. The issue with MF is that others selling MF shares can create realized gains inside the fund by selling shares of the funds investments to pay the sellers. The people left holding the MF will have these gains distributed during the year... often near year end.

When an ETF is traded that shares are not changed and the underlying investments are not sold. When shares are destroyed I believe the AP take shares of underlying investment in exchange for cash. The embedded gains/losses go with those underlying investments (with the AP) and not spread among the remaining investors. At least that is how I think it works.

 

[youbet]

MF has to pay realized capital gains, not all unrealized gains. The issue with MF is that others selling MF shares can create realized gains inside the fund by selling shares of the funds investments to pay the sellers. The people left holding the MF will have these gains distributed during the year... often near year end.

When an ETF is traded that shares are not changed and the underlying investments are not sold. When shares are destroyed I believe the AP take shares of underlying investment in exchange for cash. The embedded gains/losses go with those underlying investments (with the AP) and not spread among the remaining investors. At least that is how I think it works.

Yeah, I think you've got it.

My point is that with MF's I get get taxable CG distributions every year I have to pay taxes on. With ETF's the CG's accumulate and will be adjusted to zero at my death.

 

[mpeirce]

My point is that with MF's I get get taxable CG distributions every year I have to pay taxes on. With ETF's the CG's accumulate and will be adjusted to zero at my death.

That's the first compelling (to me) reason I've seen to have an ETF instead of the mutual find. About a third of my assets are in vtsax. I see you can convert those to VTI (but not back). hmmm

I expect I'll own some/most of those shares for the rest of my life.