Help Understanding Expense Ratios...

[saferthansome]

Hi,

So I have my retirement accounts at Fidelity and accordingly was doing research into Fidelity alternatives into some of the Vanguard funds I have (so that I could lower/eliminate my transaction fees).

I had a few questions...

1) If I was looking at a Fidelity Fund which had a .10% expense ratio (but no transaction fees) versus a Vanguard ETF with a .06% expense ratio (but that incurs a $7.95 transaction fee), would the difference be "worth it" to have the Vanguard ETF? How much money does the difference in expense ratio save in terms of real dollars (or rather, is there a way to calculate it)? I don't imagine at this point I would be rebalancing my fund more than once a year (and sometimes really only every other year.

2) Some funds have different numbers for gross expense ratio and net expense ratio, which one should I be looking at?

3) The Fidelity Spartan Advantage Class Funds often manage to beat or at least equal the Vanguard ETFs I currently hold in terms of their expense ratios... Does Vanguard have some sort of equivalent to the Fidelity Advantage Class that has even LOWER expense ratios? (Or are there any other equivalent 3-fund portfolio funds/ETFs that I could hold that beat out the Advantage Class funds?)

[Grt2bOutdoors]

The only way to determine if it's worth it to switch between Vanguard and Fidelity is to do the math.
If your investment amount is $10K - a 4bp difference in one years time will save you approximately $4. Therefore, if the transaction fee is $7.95 you will be on the losing end of the trade in year 1, but for each successive year following you will benefit by paying less in fees.

Vanguard has a few different share classes as well, but each improvement requires a substantial investment - sometimes hundreds of thousands and sometimes millions of dollars.

[livesoft]

In my opinion, once expense ratios are in the 0.20% and lower range, they do not carry as much weight in deciding which fund to use. Other factors will have more weight in those cases. Those other factors might be convenience, commission, liquidity, tax efficiency (tax cost), automatic reinvestment issues, 1099 reporting, statement layout, website appeal, and so on.

1) I would not pay a commission nowadays to purchase investments. Even $7.95 is too much.

2) I use net expense ratio because that's what one pays, but some folks feel that the gross expense ratio is a look at the future expense ratio when things are no longer subsidized.

3) Vanguard has institutional share class with lower e.r.'s, but so what? Maybe the Fidelity Spartan funds are less tax-efficient than the Vanguard funds? The expense ratio difference is not important until you have $100 million in assets anyways.

Full disclosure: I own a few Fidelity Spartan Advantage funds and many Vanguard ETFs.

[BL]

If you use low-cost funds such as Spartan, I can't see why you would bother with Vanguard if you want to stay with Fidelity (Vanguard alone suits me just fine.) I would worry more about fees over .5 or higher.

If you are going with a fee for Vanguard, it may depend on how much money your are putting in in each transaction. If you regularly put in just $100, that 7.5% would drive me crazy! Maybe I wouldn't even notice at $10,000! I wouldn't do it unless I was putting in a large chunk of money into maybe one fund one time and leave it alone forever.

[saferthansome]

Thanks everyone. I understand now. Think I will make the switch into the Fidelity funds. I didn't really know what an expense ratio was (just that lower is better) but I see that when you break it down like that with the math it really does save money. And that those fees will add up over the years.

Every time I ask questions on this board I get helpful answers quickly and both my portfolio (and my understanding of it) improves. What a great place!

[JamesSFO]

In my opinion, once expense ratios are in the 0.20% and lower range, they do not carry as much weight in deciding which fund to use. Other factors will have more weight in those cases. Those other factors might be convenience, commission, liquidity, tax efficiency (tax cost), automatic reinvestment issues, 1099 reporting, statement layout, website appeal, and so on.

+1

I think it is too easy to get solely fixated on the ER and not look at the entire package.

[saferthansome]

Maybe the Fidelity Spartan funds are less tax-efficient than the Vanguard funds?

How do I figure the tax efficiency of the various funds?

[veerain]

In my opinion, once expense ratios are in the 0.20% and lower range, they do not carry as much weight in deciding which fund to use. Other factors will have more weight in those cases. Those other factors might be convenience, commission, liquidity, tax efficiency (tax cost), automatic reinvestment issues, 1099 reporting, statement layout, website appeal, and so on.

As livesoft mentioned, other considerations are more important. I have an account with fidelity, and although some of the Fidelity Funds are cheaper I still prefer Vanguard ETFs because portability is important to me. if I have to switch to another brokerage I want my investments portable, so that I dont have sell them. ETFs are most portable, Mutual Funds - not as much.

[livesoft]

Maybe the Fidelity Spartan funds are less tax-efficient than the Vanguard funds?

How do I figure the tax efficiency of the various funds?

You have to do some math:

1. Pretend you purchased $10,000 of each fund 1, 3, 5, and 10 years ago.
2. Pretend you reinvested dividends and other distributions.
3. Pretend you judiciously tax-loss harvested as warranted.
4. Calculate how much taxes you would have paid in total at the end of 1, 3, 5, and 10 years.

If this is a Roth IRA, ignore step 3 and 4.

[pkcrafter]

You can compare tax efficiency on M*. Here's a link:

http://performance.morningstar.com/fund/tax-analysis.action?t=VFINX&region=USA&culture=en-us

This is VFINX, which is very tax efficient. To look at another fund, put the ticker in the stock/fund box at the top of the page.

Paul

[saferthansome]

You can compare tax efficiency on M*. Here's a link:

http://performance.morningstar.com/fund/tax-analysis.action?t=VFINX&region=USA&culture=en-us

This is VFINX, which is very tax efficient. To look at another fund, put the ticker in the stock/fund box at the top of the page.

Paul

Thanks for the link. I started with VTI and typed in FSTVX to compare the 2 but I don't quite understand what I'm looking at or how to apply it to a real number.

For example, the 5 year pretax return of VTI = 4.69, FSTVX = 4.58. The 5 year after tax return in VTI = 4.33, FSTVX = 3.86. Tax cost ratio VTI = .34, FSTVX = .69.

I understand the math, but does that mean that VTI is more tax efficient? Less tax efficient? And how would that efficiency affect say a $10,000 investment?

Here's the link: http://performance.morningstar.com/fund ... tion?t=VTI (don't know how to get to a link comparing the 2)

Appreciate the help.

[pkcrafter]

You can compare tax efficiency on M*. Here's a link:

http://performance.morningstar.com/fund/tax-analysis.action?t=VFINX&region=USA&culture=en-us

This is VFINX, which is very tax efficient. To look at another fund, put the ticker in the stock/fund box at the top of the page.

Paul

Thanks for the link. I started with VTI and typed in FSTVX to compare the 2 but I don't quite understand what I'm looking at or how to apply it to a real number.

For example, the 5 year pretax return of VTI = 4.69, FSTVX = 4.58. The 5 year after tax return in VTI = 4.33, FSTVX = 3.86. Tax cost ratio VTI = .34, FSTVX = .69.

I understand the math, but does that mean that VTI is more tax efficient? Less tax efficient? And how would that efficiency affect say a $10,000 investment?

Here's the link: http://performance.morningstar.com/fund ... tion?t=VTI (don't know how to get to a link comparing the 2)

Appreciate the help.

Yes, VTI is more tax efficient for the 5 year time period, but compared to other types of funds, FSTVX is also pretty efficient. Try looking at a balanced fund, dividend fund or bond fund to get some perspective. The figures are annualized, and M* calculates tax cost at highest tax rate. Go back to the tax page, or any page on funds and scroll down to the bottom and find the Glossary link in the blue bar. Open it and hit T to find definitions of tax cost ratio and tax -adjusted returns.

Paul

[saferthansome]

You can compare tax efficiency on M*. Here's a link:

http://performance.morningstar.com/fund/tax-analysis.action?t=VFINX&region=USA&culture=en-us

This is VFINX, which is very tax efficient. To look at another fund, put the ticker in the stock/fund box at the top of the page.

Paul

Thanks for the link. I started with VTI and typed in FSTVX to compare the 2 but I don't quite understand what I'm looking at or how to apply it to a real number.

For example, the 5 year pretax return of VTI = 4.69, FSTVX = 4.58. The 5 year after tax return in VTI = 4.33, FSTVX = 3.86. Tax cost ratio VTI = .34, FSTVX = .69.

I understand the math, but does that mean that VTI is more tax efficient? Less tax efficient? And how would that efficiency affect say a $10,000 investment?

Here's the link: http://performance.morningstar.com/fund ... tion?t=VTI (don't know how to get to a link comparing the 2)

Appreciate the help.

Yes, VTI is more tax efficient for the 5 year time period, but compared to other types of funds, FSTVX is also pretty efficient. Try looking at a balanced fund, dividend fund or bond fund to get some perspective. The figures are annualized, and M* calculates tax cost at highest tax rate. Go back to the tax page, or any page on funds and scroll down to the bottom and find the Glossary link in the blue bar. Open it and hit T to find definitions of tax cost ratio and tax -adjusted returns.

Paul

Oh ok, got it. So what that difference in tax cost ratio means is that over a 5 year period the average yearly difference between the two in terms of the percentage of their earnings lost to taxes was .35%.

To see if I get it, using the same 2 funds I'm gonna look at the 1 year returns and say that I invested $10,000 in each one. VTI had a 16.48% tax adjusted return, which would come to $11,648 after taxes. FSTVX had a 16.06% tax adjusted return, which would have come to $11,606. A difference of $34 (and having done that math I could have got the difference faster by just multiplying the $10,000 by the .34% differential).

Am I correct that by dividing the transaction cost ($7.95) by the tax cost differential (.34% average over 5 years) I can figure out that as long as I'm investing more than $2338 at a time (7.95/.0034) it's worth it to use the Vanguard ETF instead of the Fidelity Fund?

[livesoft]

Am I correct that by dividing the transaction cost ($7.95) by the tax cost differential (.34% average over 5 years) I can figure out that as long as I'm investing more than $2338 at a time (7.95/.0034) it's worth it to use the Vanguard ETF instead of the Fidelity Fund?

Sorry, no you cannot say that. The reasons are that there are several assumptions to what Morningstar does that do not apply to you.

[saferthansome]

Am I correct that by dividing the transaction cost ($7.95) by the tax cost differential (.34% average over 5 years) I can figure out that as long as I'm investing more than $2338 at a time (7.95/.0034) it's worth it to use the Vanguard ETF instead of the Fidelity Fund?

Sorry, no you cannot say that. The reasons are that there are several assumptions to what Morningstar does that do not apply to you.

Ok. So then how CAN I use the tax cost ratio to figure out what the real difference would be between the 2 funds for me?

[dbr]

Am I correct that by dividing the transaction cost ($7.95) by the tax cost differential (.34% average over 5 years) I can figure out that as long as I'm investing more than $2338 at a time (7.95/.0034) it's worth it to use the Vanguard ETF instead of the Fidelity Fund?

Sorry, no you cannot say that. The reasons are that there are several assumptions to what Morningstar does that do not apply to you.

Ok. So then how CAN I use the tax cost ratio to figure out what the real difference would be between the 2 funds for me?

You are missing that the taxes in question are not assessed against the fund but are just estimates of what you will pay in taxes making many assumptions about your personal tax return, including that you pay all your taxes at the maximum possible tax rate. The only accurate tax estimate is for you to run dummy tax returns assuming one investment or the other. In short, you can't use the tax cost ratio to calculate actual costs.

[saferthansome]

Am I correct that by dividing the transaction cost ($7.95) by the tax cost differential (.34% average over 5 years) I can figure out that as long as I'm investing more than $2338 at a time (7.95/.0034) it's worth it to use the Vanguard ETF instead of the Fidelity Fund?

Sorry, no you cannot say that. The reasons are that there are several assumptions to what Morningstar does that do not apply to you.

Ok. So then how CAN I use the tax cost ratio to figure out what the real difference would be between the 2 funds for me?

You are missing that the taxes in question are not assessed against the fund but are just estimates of what you will pay in taxes making many assumptions about your personal tax return, including that you pay all your taxes at the maximum possible tax rate. The only accurate tax estimate is for you to run dummy tax returns assuming one investment or the other. In short, you can't use the tax cost ratio to calculate actual costs.

Of course, thank you. Well yeah, I definitely don't pay the maximum federal tax rate. So tax cost ratio doesn't seem like (for me) a particularly valuable statistical measure, or at least I don't yet understand how to use it. At the moment all I understand is that it can give me a vague sense of whether a fund is likely to be better or worse in terms of tax efficiency, but no understanding of what better or worse might actually mean. Is there another way I should be understanding it and/or tax efficiency?

If I have to run dummy returns to figure it out... Well that's just not going to happen. And effectively, it means I'll just ignore tax efficiency when deciding between the two.

[livesoft]

Since you wrote "So I have my retirement accounts at ...", guess what? The whole question of tax cost is moot since these are tax-advantaged accounts. I tried to hint at that in my earlier post.

[pkcrafter]

Livesoft is correct, if your assets are in tax-deferred accounts then tax efficiency is not an issue. If in taxable, then the tax cost ratio is an indicator of tax efficiency. It's not designed to give you an actual tax number because that depends on several variables specific to your situation. It's enough to know that VTI is very tax efficient and the Fidelity fund is also tax efficient compared to using other, less efficient funds. Another indicator of tax efficiency is turnover. VTI turnover is 5% and that is extremely low because the ETF is another class of the underlying fund, so stocks can be transferred without cost. Fidelity has a turnover of 17%, which is still very low, but it is higher than VTI, but not likely to break you. Take a look at the tax cost ratio for Wellesley to compare.

All you need to know about tax efficiency is shown here. You can't get any more precise than that.

http://www.bogleheads.org/wiki/Principles_of_Tax-Efficient_Fund_Placement

Paul

[saferthansome]

Since you wrote "So I have my retirement accounts at ...", guess what? The whole question of tax cost is moot since these are tax-advantaged accounts. I tried to hint at that in my earlier post.

Sorry, didn't mean to mislead. I call them my retirement accounts but I'm including in that my taxable investment account. I don't have a 401k (self-employed musician) so while I do have IRAs that I contribute to I also have to save for retirement in a taxable investment account (It's all for retirement). I keep my bond funds in my IRAs but I ran out of room there so I have to keep my US and International stock funds in my taxable account.

[saferthansome]

Livesoft is correct, if your assets are in tax-deferred accounts then tax efficiency is not an issue. If in taxable, then the tax cost ratio is an indicator of tax efficiency. It's not designed to give you an actual tax number because that depends on several variables specific to your situation. It's enough to know that VTI is very tax efficient and the Fidelity fund is also tax efficient compared to using other, less efficient funds. Another indicator of tax efficiency is turnover. VTI turnover is 5% and that is extremely low because the ETF is another class of the underlying fund, so stocks can be transferred without cost. Fidelity has a turnover of 17%, which is still very low, but it is higher than VTI, but not likely to break you. Take a look at the tax cost ratio for Wellesley to compare.

All you need to know about tax efficiency is shown here. You can't get any more precise than that.

http://www.bogleheads.org/wiki/Principles_of_Tax-Efficient_Fund_Placement

Paul

Thanks. I'm wondering if there's a line (or lines) at which a fund crosses over from being seen as tax-efficient to being tax-inefficient. Just wondering how you make that kind of a judgement call... more for intellectual curiosity than anything else, wanting to understand the thinking behind the statement... I will read more.

In terms of the real practical application the reason I started this thread is because I am trying to choose between VTI vs. FSTVX and VXUS vs. FSIVX as both the international and US stock portions of my retirement portfolio sit in a taxable account at Fidelity. I was comparing the expense ratios but I realized I didn't really understand what the implications of a higher or lower expense ratio were, which eventually led to this discussion of tax efficiency ratios... But really what I want to know is... Should I invest in the Fidelity Advantage funds or the Vanguard ETFs?

If it helps give better advice... My overall portfolio (including IRAs and a Keogh) is in the mid-upper 5 figures, I am in the 15% tax bracket and my annual contributions to the taxable portion of those funds, for the time being will be in the 4 figure range.

Thanks!

[livesoft]

I would think you would have a 401(k) since being self-employed does not prevent you from having one.

Instead of FSIVX, consider FSGDX.

[saferthansome]

I would think you would have a 401(k) since being self-employed does not prevent you from having one.

Instead of FSIVX, consider FSGDX.

Wow. That's news to me. No one had ever told me that. I will look into that for sure!

And thank you for the recommendation of FSGDX.

Was also considering: FSRVX vs VNQ (REITs) and FSITX vs AGG vs. BND (Bonds) do you have any particular thoughts on which would be best for me? Both my REIT and Bond allocations are currently in my Roth IRA.

[JamesSFO]

I would think you would have a 401(k) since being self-employed does not prevent you from having one.

....

Wow. That's news to me. No one had ever told me that. I will look into that for sure!

...

Check out - https://investor.vanguard.com/what-we-offer/small-business/individual-401k?Link=facet

Fidelity offers similar solo/individual 401K product(s).