Adjusting My Portfolio - ETFs vs Mut Funds

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
jimt1000
Posts: 15
Joined: Sat May 25, 2013 5:36 am

Adjusting My Portfolio - ETFs vs Mut Funds

Post by jimt1000 »

I'm going to be migrating my very "sliced and diced" portfolio to a Core Four (as per Ferri) model. I have several million to migrate over time, probably a year or so, as I manage the taxable events of the sales and transfers. I'm going to move to a classic Cour Four model of Index Bonds, US Stocks, Intl. Stocks, and a REIT. My question is: If I have relatively large sums to move to this model platform (i.e. each of the Core 4 funds will have over $500K), isn't it best to go all ETFs versus Mutual Funds from a tax perspective at least? It seems to me that when dealing with single large chunks of investment, that an all ETF portfolio beats out, albeit ever so slightly, the indexed Mutual Funds from a tax perspective at least.

Additionally, as a follow up, is there risk with putting large sums with any one fund, ETF or Mutual Fund? I'm referring to the collapse of Lehman years ago. I think that only $500k is backed by the Fed in any one fund. So, would splitting up the investments between, say, Vanguard and iShares be a good idea for safety reasons?

Any input or suggestions would be welcomed and appreciated.

Regards.
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by grabiner »

jimt1000 wrote:I'm going to move to a classic Cour Four model of Index Bonds, US Stocks, Intl. Stocks, and a REIT. My question is: If I have relatively large sums to move to this model platform (i.e. each of the Core 4 funds will have over $500K), isn't it best to go all ETFs versus Mutual Funds from a tax perspective at least? It seems to me that when dealing with single large chunks of investment, that an all ETF portfolio beats out, albeit ever so slightly, the indexed Mutual Funds from a tax perspective at least.
If you use Vanguard, it doesn't matter. The Vanguard ETFs are a share class of the mutual funds, so they both have the same tax treatment. And with your large investments, you'll have Admiral shares, which have the same cost.

You might also look at other tax issues. If you have this large a portfolio, you are probably in a high tax bracket. Therefore, you should only hold as much in REITs as you can fit in your IRA or 401(k); in a taxable account, REITs will lose more than 1% per year to taxes, which probably cancels out the diversification benefit. And if you have to hold bonds in your taxable account, you probably want a municipal-bond fund rather than Total Bond Market Index, as you can get better after-tax returns for the same risk.
Wiki David Grabiner
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by grabiner »

If you are actually planning to invest $500K in REIT Index and will have to do it in a taxable account, you might look into a variable annuity. Another thread discusses a variable annuity which is very low cost for large investments. It charges a fixed-dollar fee rather than Vanguard's percentage fee on top of the cost of the underlying Vanguard funds, so a $500K investment in REIT Index would become tax-deferred at an additional cost of about 0.25% over the mutual fund cost (compared to 0.48% for Vanguard's variable annuity).

http://www.bogleheads.org/forum/viewtop ... 0&t=116921
Wiki David Grabiner
livesoft
Posts: 86075
Joined: Thu Mar 01, 2007 7:00 pm

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by livesoft »

I love ETFs, but if I was going to be putting $500K at a pop into a fund, I would use the mutual fund. You will get a fair price at NAV for the fund shares and will not have to worry about being taken advantage of because of misunderstandings about order submission and order execution. In particular, the depth of the order book at a given price is something that would concern me with ETF orders, but not with mutual fund share orders.

If you don't like the mutual fund shares at some point in the future, Vanguard can convert them to the ETF share class for you with no tax consequences. The other way 'round is not available. That is, one cannot buy ETF shares first and then convert to Admiral or Institutional share class mutual fund shares.

For this size portfolio I might even fly up to meet face-to-face with Vanguard people to discuss this with them.

As for splitting up the shares, I would not be worried about that, but I do use 4 different financial institutions. For example, I own shares of Vanguard funds and ETFs at Vanguard, WellsFargo, and TDAmeritrade. I am mostly worried about cyberattacks on these institutions.

I know you asked about iShares and Vanguard. I would caution you that not all ETFs have the same level of tax efficiency, so that might be something you will wish to explore if you use the ETFs of different sponsors. Since you started the thread with a mention of tax efficiency, you will need to know that the percentage of qualified dividends is not the same for ETFs even in the same space.
Wiki This signature message sponsored by sscritic: Learn to fish.
Topic Author
jimt1000
Posts: 15
Joined: Sat May 25, 2013 5:36 am

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by jimt1000 »

Great advice and replies... Thanks... I need to do some more studying before I "jump." Regards...
User avatar
Bogle101
Posts: 468
Joined: Mon Oct 01, 2012 10:14 am

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by Bogle101 »

The feds back 500k in each fund?
40% Extended Market | 40% S&P 500 | 10% REIT | 5% State Muni Bond | 5% Cash
Iorek
Posts: 1569
Joined: Fri Mar 08, 2013 8:38 am

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by Iorek »

Bogle101 wrote:The feds back 500k in each fund?
I think that might have been a reference to SIPC protection (SIPC was chartered by Congress, but AFAIK is not funded by Congress). SIPC protection is for securities held at a brokerage (in street name), up to a max of $500k per institution.

If OP invests in a mutual fund account at VG there is no need for SIPC protection because the assets of the fund are segregated in a trust (I think the wiki covers this somewhere). I am not sure if there is comparable protection for ETFs, but at least for mutual funds I would not worry about the possibility of the managing institution collapsing and losing money that way (although perhaps the security issue argues for multiple institutions).
Topic Author
jimt1000
Posts: 15
Joined: Sat May 25, 2013 5:36 am

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by jimt1000 »

Ok, after much further study, I've gotten comfortable with moving towards a pure Core 4 model (vis-a-vis the Rick Ferri Core 4 model) without further slicing and dicing in terms of getting into Muni Bonds, TIPS, etc. From an analysis of long term returns, it seems that "simpler is better" so I'm leaning heavily in just sticking to the Core 4 and leaving it at that. I might slice and dice somewhat in the future, but now, I'm planning on keeping it simple. Now, just a couple of follow up questions that seek to refine some of the recommendations/discussion above:
1) I understand the tax efficiency of ETFs versus Mutual Funds, but is one "safer" in terms of protection of risk of collapse as related to the investing institution running a given ETF or Fund? I'm specifically referring to the Lehman & Bear Stearns collapses of 2007/8. And I ask this since I'll be putting relatively large chunks of cash ($500k +/-) in each ETF as I'm currently planning. Are ETFs or Mutual Funds subject to the same risk for a long-term investor?
2) Related to the above question, what is the maximum you would put in any one ETF? In an above reply, there is discussion of government protection/insurance up to $500k. Anything above this would you split to another ETF for safety?

Thank you for the input as I really appreciate it...
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by grabiner »

jimt1000 wrote:1) I understand the tax efficiency of ETFs versus Mutual Funds, but is one "safer" in terms of protection of risk of collapse as related to the investing institution running a given ETF or Fund? I'm specifically referring to the Lehman & Bear Stearns collapses of 2007/8. And I ask this since I'll be putting relatively large chunks of cash ($500k +/-) in each ETF as I'm currently planning. Are ETFs or Mutual Funds subject to the same risk for a long-term investor?
Either one is equally safe. If you use Vanguard, the ETF and mutual fund are two share classes of the same fund, and are equally affected by any issues. And neither an ETF nor a mutual fund is owned by the management company, so they are not vulnerable to the management company's default.

The primary risk with both mutual funds and ETFs is what happens to the assets the fund holds, which is not insured. If you buy a bond fund and some of the bonds default, you will lose money on the bonds. If you have a well-diversified portfolio, even in a single fund, you reduce this risk; a few corporate defaults will not cause major losses in a fund like Total Bond Market which hold thousands of bonds.

Note that exchange-traded notes (ETNs), which look like funds, are liabilities of the issuer and are thus subject to extra risks. If you buy an ETF which tracks a stock index, the ETF itself holds the stocks and the fund companys creditors cannot collect the ETF's asset. If you buy an exchange-traded note which tracks a stock index, you have a contract with the provider to pay the value of that note, and if the provider goes bankrupt, you may not get your investment back.
2) Related to the above question, what is the maximum you would put in any one ETF? In an above reply, there is discussion of government protection/insurance up to $500k. Anything above this would you split to another ETF for safety?
Fund companies have insurance beyond the SIPC coverage, so there is no reason to limit to $500K. The SIPC coverage is more relevant to the brokerage account in which you hold the ETFs; if you order your broker to sell an ETF (or stock) and the broker takes the cash instead of giving it to you, the SIPC will cover it. But splitting among multiple ETFs won't help here; if your broker steals $1M in cash from your brokerage account, the SIPC will only cover $500K, and you will have to turn to private insurance for the other $500K. (It's still not a major risk.)
Wiki David Grabiner
boggler
Posts: 598
Joined: Thu Feb 07, 2013 1:29 am

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by boggler »

livesoft wrote:I love ETFs, but if I was going to be putting $500K at a pop into a fund, I would use the mutual fund. You will get a fair price at NAV for the fund shares and will not have to worry about being taken advantage of because of misunderstandings about order submission and order execution. In particular, the depth of the order book at a given price is something that would concern me with ETF orders, but not with mutual fund share orders.
This is interesting. Are you saying that for larger portfolios you are almost always better off with the mutual fund version?
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by grabiner »

boggler wrote:
livesoft wrote:I love ETFs, but if I was going to be putting $500K at a pop into a fund, I would use the mutual fund. You will get a fair price at NAV for the fund shares and will not have to worry about being taken advantage of because of misunderstandings about order submission and order execution. In particular, the depth of the order book at a given price is something that would concern me with ETF orders, but not with mutual fund share orders.
This is interesting. Are you saying that for larger portfolios you are almost always better off with the mutual fund version?
What matters isn't the size of the portfolio, but the size of the transaction. If you want to buy $500K of an ETF which trades at $50 per share, you have to buy 10,000 shares, and for many ETFs, there won't be another trader willing to sell that many shares at once. But if you accumulate 10,000 shares by buying 500 shares per month for 20 months, you probably don't lose much to market impact.

You can see some of the effect of market impact from the number of shares on offer when you get a quote. If an ETF offers 1000 shares to sell at $50, then you can buy 1000 with no market impact, but a limit order to buy 10,000 shares at $50 may only buy 1000 unless you raise the price for the remainder, and a market order will buy 9000 more shares at a higher price. If you get an average price of $50.05, you lost $500 to your own market impact.

And it also depends on the volume of the ETF. You can't really move the price of a high-volume ETF such as VTI (Vanguard Total Stock Market Index) or BND (Vanguard Total Bond Market Index), which trade more than a million shares per day; a large order is unlikely to cost you more than a penny per share. But if you want to buy something like VSS (Vanguard's international small-cap ETF), $500K is about 10% of the daily volume, so you will probably create a significant market impact; at best, you'll lose all of a fairly large spread. For example, there might be a market maker willing to buy a lot of shares at $49.90 or sell at $50.10, and a small trader with 300 shares to sell at $50, in the middle of the market maker's spread. If you buy 300 shares, you get a price of $50; if you buy 10,000 shares, you will have to pay $50.10 for 9700 of them.
Wiki David Grabiner
boggler
Posts: 598
Joined: Thu Feb 07, 2013 1:29 am

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by boggler »

grabiner wrote:
boggler wrote:
livesoft wrote:I love ETFs, but if I was going to be putting $500K at a pop into a fund, I would use the mutual fund. You will get a fair price at NAV for the fund shares and will not have to worry about being taken advantage of because of misunderstandings about order submission and order execution. In particular, the depth of the order book at a given price is something that would concern me with ETF orders, but not with mutual fund share orders.
This is interesting. Are you saying that for larger portfolios you are almost always better off with the mutual fund version?
What matters isn't the size of the portfolio, but the size of the transaction. If you want to buy $500K of an ETF which trades at $50 per share, you have to buy 10,000 shares, and for many ETFs, there won't be another trader willing to sell that many shares at once. But if you accumulate 10,000 shares by buying 500 shares per month for 20 months, you probably don't lose much to market impact.

You can see some of the effect of market impact from the number of shares on offer when you get a quote. If an ETF offers 1000 shares to sell at $50, then you can buy 1000 with no market impact, but a limit order to buy 10,000 shares at $50 may only buy 1000 unless you raise the price for the remainder, and a market order will buy 9000 more shares at a higher price. If you get an average price of $50.05, you lost $500 to your own market impact.

And it also depends on the volume of the ETF. You can't really move the price of a high-volume ETF such as VTI (Vanguard Total Stock Market Index) or BND (Vanguard Total Bond Market Index), which trade more than a million shares per day; a large order is unlikely to cost you more than a penny per share. But if you want to buy something like VSS (Vanguard's international small-cap ETF), $500K is about 10% of the daily volume, so you will probably create a significant market impact; at best, you'll lose all of a fairly large spread. For example, there might be a market maker willing to buy a lot of shares at $49.90 or sell at $50.10, and a small trader with 300 shares to sell at $50, in the middle of the market maker's spread. If you buy 300 shares, you get a price of $50; if you buy 10,000 shares, you will have to pay $50.10 for 9700 of them.
Interesting.
Any idea which is the better long term choice? If you do have a larger portfolio, it seems like the mutual fund offers more price certainty, but the world seems to be heading in the direction of ETFs. Normally the one-way conversion feature would make this moot, but for funds like Vanguard Total World, there are no Admiral shares and the ETF is much cheaper.
User avatar
Sammy_M
Posts: 1935
Joined: Sun Nov 25, 2007 7:30 am

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by Sammy_M »

grabiner wrote:If you are actually planning to invest $500K in REIT Index and will have to do it in a taxable account, you might look into a variable annuity. Another thread discusses a variable annuity which is very low cost for large investments. It charges a fixed-dollar fee rather than Vanguard's percentage fee on top of the cost of the underlying Vanguard funds, so a $500K investment in REIT Index would become tax-deferred at an additional cost of about 0.25% over the mutual fund cost (compared to 0.48% for Vanguard's variable annuity).

http://www.bogleheads.org/forum/viewtop ... 0&t=116921
Another advantage occurs to me. Placing in a variable annuity, as opposed to a taxable account, may also offer asset protection benefits in some states.
Cash
Posts: 1572
Joined: Wed Mar 10, 2010 9:52 am

Re: Adjusting My Portfolio - ETFs vs Mut Funds

Post by Cash »

boggler wrote:Normally the one-way conversion feature would make this moot, but for funds like Vanguard Total World, there are no Admiral shares and the ETF is much cheaper.
Buy the mutual fund and hope that they introduce admiral shares one day. You're not giving up too much in cost. Or buy the ETF until they introduce admiral shares. I think you're fairly young and still contributing, so if VG introduces admiral shares in the next few years and you switch from buying the ETF to buying the mutual fund, your mutual fund purchases will eventually outweigh what you have in ETF purchases anyway.
Post Reply