Mutual fund, or ETF based on the same mutual fund?
June 14, 2016 2:39 PM   Subscribe

Vanguard provides this handy chart to explain the difference between ETFs and mutual funds. But are there any circumstances where one should prefer to buy directly into a mutual fund rather than an exchange-traded version of the same fund?

For concreteness, here's Vanguard's BND, a bond market index ETF that is also offered as Admiral shares or Investor shares. With 10K to invest, is it better to get Admiral shares in a new Vanguard account, or buy shares of the ETF through an existing online brokerage account? (The expense ratios are the same, and the transaction costs are negligible for a one-time thing.)
posted by RedOrGreen to Work & Money (19 answers total) 12 users marked this as a favorite
Use that site's "compare" feature. If you compare the "Growth of $10,000" tab's charts for those three over 10 years, the ETF underperforms.

ETFs' big advantage is that they aren't (very) actively managed. However, that also often means that if a stock is tanking, there isn't a manager to yank it until it's hit a significant trigger.

There are some generalizations that I hear. One is that they're cheaper than funds. In general, I've found that to be true except when it isn't. If you aren't buying Vanguard's branded ETFs, my guess is that they charge you a transaction fee. I can't see what Vanguard's is, but $75 is common at other custodians. $75 is no big thing on a $100k order, but that's not what most of us are doing.

Another generalization is that their expense ratio is lower. This is generally true but please double check. I looked at a portfolio the other day that had ETFs with a .97% expense ratio AND a transaction fee. That's not cheaper.

Another is that they're more tax efficient. Again, in my experience that's usually been true but there have been unpleasantly surprising exceptions.

ETFs are great, but they don't solve all the ills of mutual funds. And, just as a general warning, don't assume that what's generally true for ETFs is true for the exact one you are looking at at that moment.

Personally, I use more mutual funds than ETFs because I like the variety and I trade frequently enough that the $75 transaction fee is prohibitive. In addition to that, I like Socially Responsible Investing, and managers of SRI mutual funds are likelier to do shareholder actions. For instance, Parnassus Funds, Pax Funds, and Green Century funds all do shareholder advocacy.

All that said, I do use a mix- there are a few ETFs that I like enough that I probably won't be buying and selling them often, so I risk the transaction fees, plus I like having a variety of passive and active management styles in my little portfolio.
posted by small_ruminant at 3:35 PM on June 14, 2016 [1 favorite]

Sorry, most of those comparisons don't apply as between Vanguard ETFs and funds, as they have this proprietary approach that makes the ETFs essentially equivalent to the mutual funds. I'll admit I don't understand the technical implementation of it (the ETF actually trades pieces of the mutual fund, or something? To the extent that's allowed under the regs [cite]), but anyway they're not similar like most ETF-to-fund choices, they are the same in terms of underlying bond holdings.

The reason that the investor shares underperform the admiral shares is because admiral has a lower expense ratio. The ETF does not underperform during any of the periods where it has existed.

When considering Vanguard funds / ETFs specifically, I would focus on how much you'll be investing and how many transactions you plan to have over what period. If you will invest enough to get the admiral shares, then you should choose those over the investor shares because the expense ratio is lower. If not, you can kind of back-door into the lower expense ratio by buying the ETF. But, if you are investing enough that you would need a very large number of shares of the ETF to make your purchase, like over 10,000, you should purchase the fund instead because you are likely to incur greater transaction fees, and may even need to confirm wiht your broker by phone, to trade that number of shares - but you could do it all as a single mutual fund purchase allocated by dollars rather than by shares.
posted by Joey Buttafoucault at 4:14 PM on June 14, 2016 [3 favorites]

It looks like the Admiral Fund has a $10k minimum.
posted by small_ruminant at 4:30 PM on June 14, 2016

Interesting article from Kiplinger about Vanguard ETFs vs Vanguard mutual funds.
posted by small_ruminant at 4:32 PM on June 14, 2016 [3 favorites]

Best answer: You are asking specifically about Vanguard funds. Vanguard actually has a patent on combining regular mutual funds and ETFs as different share classes of the same fund.

The "handy chart" you linked does a good job of comparing. Both the Admiral share class and the ETF will have very close to the same expense ratio. The biggest difference is that the ETF, since it is traded on the stock market, has a bid-ask spread and can vary in price point during the day and to be safe, you should execute using limit orders. With the mutual fund, you don't have to worry about that. With ETFs, you must execute whole shares, so you must calculate yourself how many shares to trade without exceeding your available cash. With mutual fund shares, you can specify an exact dollar amount to trade, without worrying about number of shares, which can be fractional.

If you hold your shares in a Vanguard brokerage account, then there are no charges for trades of either type. If you hold your shares at a different brokerage, you will probably pay commissions for both types of shares. Many non-Vanguard brokerages won't carry the lower cost Admiral share class.

In my opinion, if you are buying Vanguard funds in a Vanguard brokerage, the regular mutual fund shares are easier to buy and sell with less hassle. The performance of the two, Admiral and ETF, since they are the same fund, are virtually identical as long as you are matching Admiral and ETF in the same mutual fund.

Vanguard has some funds and ETFs which have similar names but are not actually the same fund. In that case they will perform slightly differently as indicated in small_ruminant's link above. But I assume you are not talking about those.
posted by JackFlash at 4:56 PM on June 14, 2016 [2 favorites]

Best answer: Vanguard-specific funds aside, I think generally ETFs are superior in a lot of ways, though this is not always the case. For example, there are actively managed ETFs which charge high fees. There are also index mutual funds, designed to track an index, which charge very low fees that rival those of ETFs. ETFs are generally seen as more tax efficient because if they're passive, there will be minimal trading, which limits any capital gains distributions. However, there are tax-efficient mutual funds (with very low turnover ratios) as well, especially if they too are tracking an index.

The biggest difference is the pricing. ETFs are traded in real time like any other stock and are priced by the market. This means that theoretically, they could trade at a premium or a discount to the actual value of the underlying securities. Usually any premium or discount is eliminated through arbitrage, but that's not a guarantee. There is also a bid-ask spread on ETFs which is wider if you're getting exposure to a less liquid market. There is also the risk of "flash crashes" with ETFs. Mutual funds only price once a day, after market close, and they are priced at their net asset value (NAV), which is the value of the fund's assets minus liabilities. Shareholders will always get the NAV.

Another distinct benefit of ETFs is that you can short them, which you cannot do with mutual funds.
posted by triggerfinger at 5:07 PM on June 14, 2016 [2 favorites]

ETFs are generally seen as more tax efficient because if they're passive, there will be minimal trading, which limits any capital gains distributions.

In the case of the paired Vanguard fund/ETF, they are identical in capital gains distributions. One of the reasons for pairing the two, and part of the Vanguard patent, is that they can take advantage of the capital gains minimization of the ETF and share that with the mutual fund. So there is no difference. Both have low capital gains. And of course this is irrelevant if held in a tax-advantaged retirement account.
posted by JackFlash at 5:18 PM on June 14, 2016 [2 favorites]

Another distinct benefit of ETFs is that you can short them

The word "short" should not even be in the vocabulary of someone with $10K to invest. Frankly, it shouldn't be in the vocabulary of any ordinary investor.

Because of the way ETFs work, there is always the possibility that the ETF shares and the value of the underlying basket can temporarily diverge. This is unlikely to be a big problem for an investor unless the investor lacks the discipline (or the liquidity) to avoid panic sales during market disruptions/serious declines. The advantages are, however, modest at best for the long-term investor, especially in retirement accounts, so I think the generic mutual fund probably maintains a small edge over the generic ETF.
posted by praemunire at 5:25 PM on June 14, 2016 [1 favorite]

Mutual funds offer fractional shares for purchases, so if you intend to put $100 in each month, you can do so without having to deal with remainders and manually purchasing ETFs. Most brokers will let you do synthetic DRIPs on ETFs so there's no problem if you just want to do a one time purchase and let it reinvest.

With vanguard funds, the ETF's expense ratio is generally identical to the equivalent admiral class mutual fund, so if you don't have the buying power to start with admiral funds, the ETF's slightly better.

You can get many vanguard ETFs with no transaction cost through brokers like Ameritrade.

If this is a medium to long term investment, BND may not be the best option, IMO.
posted by Candleman at 5:59 PM on June 14, 2016 [2 favorites]

To clarify, I was only addressing the first part of the question regarding the general differences between mutual funds and ETFs (which is in itself a good question, as there are structural differences between the two); as the specifics of the Vanguard funds had already been addressed.

The ability to short ETFs is, again, a general difference between ETFs and funds and not in any way a statement on whether the OP or ordinary investors or anyone else should or shouldn't be shorting anything.

(Though short selling in and of itself isn't inherently a bad thing and the existence of short sellers in the market is a big part of the reason that ETF investors enjoy such low costs to begin with, even with Vanguard. )
posted by triggerfinger at 6:24 PM on June 14, 2016 [1 favorite]

I would echo Candleman's recommendation to avoid the BND ETF or any bond ETF. Because of the way ETFs work, with prices changing throughout the day, they depend on active traders to keep the price close to the value of the underlying bonds. But many bonds are illiquid, which means they are not actively traded which makes pricing difficult. You can get large spreads between the price of the ETF and their intrinsic value which can be to the disadvantage of customers. The regular open-ended Vanguard mutual fund does not have these problems.

On the other hand, broad market stock funds like Vanguard Total Stock Market and Vanguard Total International do not have the liquidity and pricing problems.

Still, unless you are the type who likes active trading, and that's a bad idea anyway, you will generally find it easier to buy Vanguard regular mutual funds.
posted by JackFlash at 8:17 PM on June 14, 2016 [3 favorites]

I'd buy 10k of Admiral shares. No transaction fee for the initial purchase AND you can reinvest the quarterly dividends at no cost. Also, if you ever want to add more money to the account, there's no transaction fee.

The two big differences I see between mutual funds and ETFs:
1. ETFs are bought/sold thru a broker so there are transaction fees.
2. ETFs are more stock-like in that the prices change throughout the day and you can short them, use them for margin, etc.

For the average long-term investor, I think mutual funds are the clear winner.
posted by LoveHam at 4:34 AM on June 15, 2016 [2 favorites]

If you are going to invest for the long term, I would go with the fund.

If you plan on trading, I would go with the ETF, but doing that will generate a bit more in fees, etc., etc.
posted by freakazoid at 8:14 AM on June 15, 2016 [1 favorite]

Again, please do not pay any money for buying or selling index fund ETFs. It can be done for free as long as you're not rapidly buying and selling them.

Vanguard does not charge for their own ETFs.
TD Ameritrade has most of the good ones for free - select "Fund Family" to see all of the Vanguard ones together. This is riskier, as either Vanguard or Ameritrade could decide to discontinue the relationship, but it's been steady for years.
Fidelity does not offer Vanguard funds for free but does have similar ones of their own.
posted by Candleman at 9:42 AM on June 15, 2016 [2 favorites]

Response by poster: Lots of good advice in the thread, thanks!

A couple of minor points of clarification: I was looking at my Sharebuilder (part of Capital One 360, formerly ING) account, and they allow you to buy into a diversified portfolio of ETFs for a flat fee. In the example I was building, I could pick Vanguard Index ETFs for each category (Large Cap Growth, Mid Cap, Small Cap, Int'l, etc.) and that got me thinking - why not buy the same funds directly from Vanguard? The BND example was just one component of a larger, moderately aggressive ETF portfolio.

> If you plan on trading, I would go with the ETF, but doing that will generate a bit more in fees, etc., etc.

Agreed. Also not relevant to me - I have a day job (writing comments on Metafilter) and managing money is not my competency. But the part I still don't get is this:

> If you are going to invest for the long term, I would go with the fund.

I don't quite see that. Aside from the $18.95 fee (which seems minor for a one-off investment into a large, diversified portfolio), what's wrong with buy-and-hold on a basket of ETFs instead of the (exactly matched) Vanguard mutual funds?

(And thanks to everyone for educating me about the uniqueness of the Vanguard ETF - Mutual fund dual availability. I'd thought that they all worked like that.)
posted by RedOrGreen at 10:11 AM on June 15, 2016

Best answer: Well, if you are stuck at Sharebuilder, then obviously the ETFs will incur lower fees. That has nothing to do with the comparison between Vanguard ETFs and open-ended mutual funds. That's an issue related to Sharebuilder. It would have helped if you had mentioned that earlier.

There's nothing wrong with buy and hold with ETFs. It's just that transactions are more complicated. Make sure you understand bid/ask spreads and how to execute limit orders. If you are comfortable with that, fine.

Unfortunately, many people get sucked into active trading of ETFs because of the gambling attraction and excitement of the daily stock market.
posted by JackFlash at 10:40 AM on June 15, 2016 [2 favorites]

I hate Sharebuilder even as I very much like CapitalOne360. Very frustrating.
posted by small_ruminant at 11:04 AM on June 15, 2016 [1 favorite]

Well, if you are stuck at Sharebuilder

At least in theory, Vanguard lets you repatriate its own funds and ETFs from other brokerage accounts as an in-kind transfer. I've been considering this with Sharebuilder, and if you're inclined to stick with Vanguard's offerings, that may make sense unless you're looking at a one-off buy-and-hold. The biggest issue specific to Sharebuilder's 'Portfolio Builder' is that you end up with a hatful of ETFs, and your options for selling are either 'one at a time' or 'everything at once'.
posted by holgate at 12:10 PM on June 15, 2016 [1 favorite]

Why couldn't you do that between any custodians? Everyone allows in-kind transfers unless they don't hold that particular fund at all. (There are some other rules that pop up- like most 401ks make you rollover in cash to your IRA.)
posted by small_ruminant at 9:37 PM on June 15, 2016

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