Tweaking expense ratios with Vanguard VIPERs

[Nords]

Spouse and I started our investing with Fidelity over 20 years ago and have no reason to change. We've never had any horrible Fidelity experiences (although others have) and we've been aware of some older customer-service problems at Vanguard (although perhaps a very small fraction of their customers).

I'm enamored of Vanguard's expense ratios, but in our youthful ignorance we stuck to actively-managed mutual funds. Fidelity also charges $75 fees to trade in non-supermarket funds so you're a captive customer. About eight years ago, when we started ditching our mutual funds for index ETFs/stocks, there was no real incentive to move to Vanguard.

I've been vaguely aware of Vanguard's ETFs but I confused them with Fidelity's $75 trading fee. (Duh.) It wasn't until last week that I saw $8 VIPER commissions mentioned while going through George Fisher's asset-allocation tutorial (thanks for the link, George!). I finally realized that we could invest in VIPERs for a fraction of the expense ratios that we were paying for our ETFs. Maybe we could save a pile of money, too.

Our ER portfolio holds three ETFs: iShares' Dow Select Dividend (DVY, 0.40% ER) and S&P600 Small-cap Value (IJS, 0.25%) plus Powershares' International Dividend (PID, 0.62%). I tried to see how much we could save by duplicating them with VIPERs.

The closest VIPER to DVY seems to be Vanguard's high dividend yield (VYM, 0.25%). It's only been around for about a year, but it's lost only 10% in that time compared to DVY's 20%. The sectors are a bit different from DVY and the yield is a lot lower (3.2% instead of 4.6%) but VYM's held its value better. The biggest difference is that DVY is very high in financials (38%) and has been pounded by their epic losses. Owning VYM would also save 0.15% in expenses each year.

VIG is based on Mergent's Dividend Achievers Select Index as opposed to DVY's Dow Select Dividend Index, but it has a much lower 1.7% yield and a similar 0.28% ER to VYM. VIG has only been around for a couple of years, but in that time it's over 15% ahead of DVY.

Two potential drawbacks to VYM & VIG are that they're very small ($115M-$160M) and thinly traded (21,000-35,000 shares/day) so spreads & NAV premiums might be a bit larger. This is not much of an issue for long-term holders and the funds will probably grow quite a bit in the next few years.

IJS's equivalent seems to be VBR, which is based on MSCI's small-cap value index. It's been around for four years and its trading volume is rising. VBR's ER is only 0.12%, less than half of IJS.

PID is tough to replicate with VIPERs because PID is based on Mergent's Dividend Achievers index of non-US stocks. (Having said that, PID is 20% US stocks.) Nearly half of PID is held in British & Canadian stocks. It's essentially an English-language large-cap global value fund with a 4.2% dividend. The closest VIPERs would probably be VEA (Euro/Pac) or VEU (ex-US) and it's still a poor comparison, but the ERs are 0.15% and 0.25% compared to PID's 0.62%. None of these funds have been around long enough to run up a "real" record but I like PID because it's hard to lie about dividends.

If we'd gone with VYM, VBR, and VEA our ER would have dropped from a weighted average of 0.42% to 0.17%. That saves $2500/year on a $1M portfolio.

However (there's always a "however") we'd be paying a healthy slug of cap gains taxes on DVY & IJS (taxable accounts) and giving up quite a bit of dividend yield to save on the ERs. I have a sneaking suspicion that we'd also be bailing on DVY's financials just as they hit bottom, which would hurt us in the long run-- especially since we're reinvesting the dividends. That's enough rationalization justification to stick with the status quo until at least 2010.

But if you're starting to research ETFs, give Vanguard a good hard look. It's a great way to enjoy low ERs without having to become a captive Vanguard customer, and choices will only get better. I suspect I'll have to revisit our inertia in a few years-- especially if we're rebalancing.

So I'm keeping an eye on this, and I'd appreciate it if the board would help me find holes in my logic.

[CCdaCE]

Ahhh, after the "perfect plan" again. But, I can't argue with anything you've written. The other positive to bailing out during DVY's low is that you'll hopefully pay less taxes.

The only question is what you expect dividends and taxes to do over your holding period. Assuming that's 20 years or more, if dividends keep falling by the wayside, and ER continues to be low, maybe you've made the right choice. But, you're not hoping for falling dividends and increasing taxes, if you're after dividends for income. Seems to me, realizing a large cap. gain, in order to save a few hundredths of a percent might be chasing the perfect plan too far.

All of this requires rebuilding the carb. on your crystal ball, for added horsepower.

-CC

[Hillbilly]

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I finally realized that we could invest in VIPERs for a fraction of the expense ratios that we were paying for our ETFs. Maybe we could save a pile of money, too.

I'm headed the same direction. My "partners" at Longleaf are starting to look like indexers (at a cost). Just got my first piece of total market viper a few weeks back. My Longleaf funds are costing me ER's of 0.89% and 1.57%.

Quote:

Our ER portfolio holds three ETFs: iShares' Dow Select Dividend (DVY, 0.40% ER) and S&P600 Small-cap Value (IJS, 0.25%) plus Powershares' International Dividend (PID, 0.62%). I tried to see how much we could save by duplicating them with VIPERs.

These are good ETFs with low expenses. I think I should have waited on my DVY purchase but it is a small chunk of change.

Quote:

The closest VIPER to DVY seems to be Vanguard's high dividend yield (VYM, 0.25%). It's only been around for about a year, but it's lost only 10% in that time compared to DVY's 20%. The sectors are a bit different from DVY and the yield is a lot lower (3.2% instead of 4.6%) but VYM's held its value better. The biggest difference is that DVY is very high in financials (38%) and has been pounded by their epic losses. Owning VYM would also save 0.15% in expenses each year.

I agree with your financials statement. My first thought, "Am I really buying a sector fund to some degree with DVY?" My trade off would be VYM instead of DVY (I may trade up soon). VYM seems to be a better ETF if you are not looking at yield only.

Quote:

VIG is based on Mergent's Dividend Achievers Select Index as opposed to DVY's Dow Select Dividend Index, but it has a much lower 1.7% yield and a similar 0.28% ER to VYM. VIG has only been around for a couple of years, but in that time it's over 15% ahead of DVY. Two potential drawbacks to VYM & VIG are that they're very small ($115M-$160M) and thinly traded (21,000-35,000 shares/day) so spreads & NAV premiums might be a bit larger. This is not much of an issue for long-term holders and the funds will probably grow quite a bit in the next few years.

Excellent points, I don't like the trading volume.

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IJS's equivalent seems to be VBR, which is based on MSCI's small-cap value index. It's been around for four years and its trading volume is rising. VBR's ER is only 0.12%, less than half of IJS.

This would be my pick of the VG ETFs also.

Quote:

PID is tough to replicate with VIPERs because PID is based on Mergent's Dividend Achievers index of non-US stocks. (Having said that, PID is 20% US stocks.) Nearly half of PID is held in British & Canadian stocks. It's essentially an English-language large-cap global value fund with a 4.2% dividend. The closest VIPERs would probably be VEA (Euro/Pac) or VEU (ex-US) and it's still a poor comparison, but the ERs are 0.15% and 0.25% compared to PID's 0.62%. None of these funds have been around long enough to run up a "real" record but I like PID because it's hard to lie about dividends.

I had decided to wait this one out (VEU). Like you, I like to see real long term results somewhat just to confirm nothing is seriously wrong.

Quote:

If we'd gone with VYM, VBR, and VEA our ER would have dropped from a weighted average of 0.42% to 0.17%. That saves $2500/year on a $1M portfolio.

That was the driver for me to look into these and the index effect that is appearing at Longleaf.

Quote:

However (there's always a "however") we'd be paying a healthy slug of cap gains taxes on DVY & IJS (taxable accounts) and giving up quite a bit of dividend yield to save on the ERs. I have a sneaking suspicion that we'd also be bailing on DVY's financials just as they hit bottom, which would hurt us in the long run-- especially since we're reinvesting the dividends. That's enough rationalization justification to stick with the status quo until at least 2010.

Gotta pay Uncle Sam his part....I'm about 75% 401K and 25% outside. I would go in small steps trying to lower my tax impacts.

You were much quicker than me to realize that active management can be a drag. I remember once where Bogle said the only way he knew to control market risk (with index funds) was to control the amount one invested in the stock market (aka asset allocation). All the other stuff (ie active management) is not a risk with the indexes. My focus is to start selling my large Longleaf positions over time and while like you looking for that low cost provider. Vanguard still remains one shop that I admire and feel they would fit in nicely.

Hillbilly

[Hillbilly]

Forgot to add Nords, when it gets tough or a pain in the a$%, I keep thinking about the DW and how good she is at investing:

http://www.early-retirement.org/foru...gle-26711.html

DW seems to use active management well .

Hillbilly

[LOL!]

I thought that vanguard canned the name VIPERS (not a a great marketing ploy) and now calls these things ETFs which is what they are. Anyways, you probably can't find VIPERS on their web site anymore: https://personal.vanguard.com/us/funds/etf

I would not buy something with a less than about 100,000 average daily trading volume. Also, an ETF with lower than $100 million capitalization probably isn't going to make it. Some have already folded up shop.

Also lots of threads about mutual funds versus ETFs on the diehards forum for your reading pleasure.

[Maurice]

I doubt any Vanguard ETFs will be folding up shop. I suspect they do enough market research before they launch, plus they're not into esoteric niche products.

Nords - I've done calculations and reached similar conclusions. In my case I bought into ETFs before Vanguard had any. I have a lot of iShare products that are now duplicated by Vanguard for a lower ER. In my IRA I've moved to VG, but in the taxable it just doesn't make sense. New moneys go in the VG equivalents, but I'm not selling the iShares.

Also, I agree with your logic about the bank stocks in your dividend fund.