ETF vs Index Fund

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DietPepsi
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ETF vs Index Fund

Post by DietPepsi »

I wasn't sure if this was "theory" or "personal" but decided to post it here.

I have $20,000 I'm planning to invest for 5-10 years. I'm currently in VFIAX (vanguard 500 admiral) and VSMAX (vanguard small cap admiral) at 50/50. I'm planning on moving the $10,000 from Vanguard 500 admiral to the Vanguard total market but I'm considering putting it into the ETF version instead. I am also considering doing the same with the small cap fund (moving it to the ETF version). I feel like with just $10,000 when the market is down 1% I have a chance of dropping below the admiral class and eventually being converted to investor shares. Is there any downside to converting to the ETF versions? I will not be actively trading these ETFs once purchased btw.

Also, can someone explain to me the premium/discount aspect of an ETF? AKA, the difference between "NAV" and market price. Is there something I should know, why does this exist? Do I take this into account when I purchase?

Thanks
livesoft
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Re: ETF vs Index Fund

Post by livesoft »

Will you automatically re-invest dividends? That would occur by different methods with mutual funds and with ETFs. In your case, I would stick to Admiral shares. They are not going to pull them away if they drop in price unless they stay down for a number of months. They would also convert back to Admiral anyways.
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Epsilon Delta
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Re: ETF vs Index Fund

Post by Epsilon Delta »

DietPepsi wrote:Is there any downside to converting to the ETF versions?

Also, can someone explain to me the premium/discount aspect of an ETF? AKA, the difference between "NAV" and market price. Is there something I should know, why does this exist? Do I take this into account when I purchase?
One downside an EFT is that you don't understand them. Since you should not invest in things you don't understand this means you have to do more work before investing in an EFT. :happy

You might want to consider just how bad it will be if your admiral shares are demoted to investor shares. My answer to this is "not very". If you quantify it it will probably come to under $10 per year.
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DietPepsi
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Re: ETF vs Index Fund

Post by DietPepsi »

Epsilon Delta wrote: One downside an EFT is that you don't understand them. Since you should not invest in things you don't understand this means you have to do more work before investing in an EFT. :happy
I completely agree with you but that's why I'm here, to get a better understanding :happy
livesoft wrote:Will you automatically re-invest dividends? That would occur by different methods with mutual funds and with ETFs. In your case, I would stick to Admiral shares. They are not going to pull them away if they drop in price unless they stay down for a number of months. They would also convert back to Admiral anyways.
I would likely be reinvesting but how do ETFs handle this? A quick google search just gave me information on good "dividend etfs"
livesoft
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Re: ETF vs Index Fund

Post by livesoft »

ETFs don't handle this. Your broker handles this. Every broker seems to do it differently. How does your broker do it? You need to ask them and perhaps get it in writing, too.
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livesoft
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Re: ETF vs Index Fund

Post by livesoft »

Here is a recommendation on how to learn about ETFs:

Do not buy $10,000 worth now. Buy one or two shares of the ETF you are considering. See how you like the experience. Of course, one should not pay a commission to buy and/or sell, so doing a few small transactions will help you learn something. Wait a few months to see how you like owning these things. Maybe wait until the next dividend is paid to see what happens. If you like what happens, then ETFs are probably for you. If you don't like what happens, then ETFs are probably not for you.
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SpringMan
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Re: ETF vs Index Fund

Post by SpringMan »

If your account is at Vanguard, there is no advantage to using Vanguard ETFs instead of the corresponding mutual funds. You can not buy $10,000 worth of an ETF because you must purchase an integer number of shares. I suppose you could purchase the mutual fund and have Vanguard do a free conversion to the ETF but what is the point. Do you have a brokerage account? You need to open one to buy ETFs. You should go with admiral shares. They will not be demoted if they drop due to market conditions but may be if you transfer out or sell shares below the minimum.
Best Wishes, SpringMan
Topic Author
DietPepsi
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Re: ETF vs Index Fund

Post by DietPepsi »

Thanks for the replies guys. I'm with you I'd just like to learn more about ETFs. Can someone explain premium/discount aspect of an ETF? Also, how does Vanguard handle dividends for ETFs?
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grabiner
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Re: ETF vs Index Fund

Post by grabiner »

DietPepsi wrote: I feel like with just $10,000 when the market is down 1% I have a chance of dropping below the admiral class and eventually being converted to investor shares.
This won't happen. Vanguard does reserve the right to demote Admirals, but it won't normally do this if the change is due to market movements, and it will give you plenty of time to make it up.

I did get demoted once. I sold most of my holdings in a fund in November 2008. In May 2009, I was at less than half the Admiral threshold, and Vanguard notified me that I would be converted to Investor shares in two months unless I put enough in to get back to the threshold. I had no intention of putting enough in, so I was demoted in July, after eight months as an underwater Admiral.
Also, can someone explain to me the premium/discount aspect of an ETF? AKA, the difference between "NAV" and market price. Is there something I should know, why does this exist? Do I take this into account when I purchase?
An ETF trades on the stock market, so it can trade at whatever price investors are willing to buy and sell it. The NAV is the value of the underlying stocks. If it happens that an ETF which represents $100 worth of stock is trading for $101, then it has a 1% premium.

For most ETFs, the creation-redemption process keeps the premium and discount small But for ETFs which trade illiquid stocks (which may be hard to purchase at the market price) or foreign stocks (which do not have a current market price when the foreign market is closed), there may be a premium or discount. For foreign ETFs, the premium or discount is more likely to be fake; if the Japanese stock market is closed and a Japan-stock ETF is trading at 1% above NAV, this may just mean that traders expect the Japanese market to open 1% higher than yesterday's close.
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Novine
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Re: ETF vs Index Fund

Post by Novine »

While I agree that one should understand how ETFs differ from mutual funds, a lot of the commentary seems to be unnecessarily complicated for what the OP wants to accomplish with his funds. I personally have some of my retirement funds at Vanguard in ETFs to be able to take advantage of the lower ERs with the ETFs versus what I would have had to pay getting Investor class shares of the equivalent mutual fund. When you're purchasing ETFs for one of the major Vanguard funds, you won't see much of a premium difference and if you're buying and holding for 10 years, you won't notice the difference 10 years from now. You can have your ETF dividends automatically reinvested. That's how I have mine set up.
livesoft
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Re: ETF vs Index Fund

Post by livesoft »

Please tell us how your dividends are automatically reinvested. If the share is trading at $80 a share, does Vanguard sell you the share at $85 when it buys shares for you with your dividend money?

With a mutual fund, dividends are re-invested at NAV with no frictional losses or more importantly, no hanky-panky. With ETFs, you are subject to the goodwill of your broker and the vicissitudes of market volatility because the share price you are charged is completely out of your control.
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Clivus1
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Re: ETF vs Index Fund

Post by Clivus1 »

ETF investing allows you to sell your investment when you like and set the price using limit orders. This is not true with funds which settle transactions when the market closes.

ETFs can have tax advantages. Due to structural differences mutual finds incur more capital gains. Typically an ETF investors only incurs a capital gain when selling shares.

One disadvantage of ETF investing is the additional expense of the bid ask spread incurred with each transaction.

The choice between the funds and ETFs for the index investor is more complex than many make is seem.
DoubleClick
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Re: ETF vs Index Fund

Post by DoubleClick »

Clivus1 wrote:ETFs can have tax advantages. Due to structural differences mutual finds incur more capital gains. Typically an ETF investors only incurs a capital gain when selling shares
Though true, this doesn't apply to the OP's case because Vanguard ETFs are shares of conventional Vanguard index funds.
Q: How does Vanguard's ETF share-class structure lend itself to tax efficiency?

Joel Dickson: We developed our unique share-class structure, in which the ETF is a share class of a traditional index mutual fund, with an eye toward tax efficiency. Combining multiple share classes gives the fund a larger pool of assets, which can lead to broader diversification and lower costs, which in turn can lead to better pre-tax outcomes, in our view.

At the same time, we believe that tax realizations can be mitigated by coupling the in-kind redemption process that is predominantly used in the ETF structure with appropriate tax-management practices in the traditional share class. With a traditional fund structure, fund managers have the ability to realize losses—which can't be done through the in-kind redemption process—that can be used to offset those gains that might have resulted from other portfolio management activity. Because established, traditional mutual funds generally have many more stock lots from which to select when selling shares to meet redemption requests, fund managers can often generate capital losses when raising cash to fund shareholder redemptions. Remember that taxes are managed at the overall portfolio level, not at the share-class level. As a result, tax efficiencies realized by Vanguard's multiclass structure benefit shareholders of all share classes—including ETF and traditional—of a given fund.
From: https://advisors.vanguard.com/VGApp/iip ... Efficiency
Novine
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Re: ETF vs Index Fund

Post by Novine »

"Please tell us how your dividends are automatically reinvested. If the share is trading at $80 a share, does Vanguard sell you the share at $85 when it buys shares for you with your dividend money?"

I have these retirement funds with Vanguard so it's done through VBS.

https://personal.vanguard.com/us/whatwe ... endprogram

From reviewing the trading history, it appears that they place a market order at the beginning of the day. I don't see any significant downside to doing it this way as opposed to being in a mutual fund and having your dividends reinvested based on the price at the end of the day. If there's a case to be made against doing it, it's on the basis that some investors want the flexibility of reinvesting those dividends elsewhere or at another time. But that's an argument to be made against automatic reinvesting, not against doing it via an ETF versus a mutual fund. For me, ETFs were a way to capture the lower ER available to Admiral shares when I didn't have enough invested to qualify for Admiral shares. That doesn't appear to be as much an issue for the OP but it might matter to others getting started with Vanguard.
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Taylor Larimore
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Re: ETF vs Index Funds ?

Post by Taylor Larimore »

DietPepsi wrote:I wasn't sure if this was "theory" or "personal" but decided to post it here.

I have $20,000 I'm planning to invest for 5-10 years. I'm currently in VFIAX (vanguard 500 admiral) and VSMAX (vanguard small cap admiral) at 50/50. I'm planning on moving the $10,000 from Vanguard 500 admiral to the Vanguard total market but I'm considering putting it into the ETF version instead. I am also considering doing the same with the small cap fund (moving it to the ETF version). I feel like with just $10,000 when the market is down 1% I have a chance of dropping below the admiral class and eventually being converted to investor shares. Is there any downside to converting to the ETF versions? I will not be actively trading these ETFs once purchased btw.

Also, can someone explain to me the premium/discount aspect of an ETF? AKA, the difference between "NAV" and market price. Is there something I should know, why does this exist? Do I take this into account when I purchase?

Thanks
Diet Pepsi:

Few people know more about ETFs and mutual funds than Boglehead, Rick Ferri, author of The ETF Book. This is what he wrote for Forbes when asked a similar question:

To ETF or Not to ETF?

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
livesoft
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Re: ETF vs Index Fund

Post by livesoft »

Novine wrote:From reviewing the trading history, it appears that they place a market order at the beginning of the day. I don't see any significant downside to doing it this way as opposed to being in a mutual fund and having your dividends reinvested based on the price at the end of the day. ....
Thanks for the info. We have been admonished not to place market orders for ETFs at the open because one can get bad prices.

For folks worried about bid/ask spreads and premium/discount to NAV, the way one's broker does automatic re-investing probably has a bigger impact than either of these other things. It is interesting that folks apparently don't notice, so I will give an explicit example in reinvesting BIV dividend.

First here is an intraday chart of the price of BIV for April 8 which shows BIV traded between above 88.24 and 88.10 with the lower price near the end of the trading day:
Image

TDAmeritrade told me that it reinvested BIV for me at a price of $88.259 at 15:51 to 15:53 that day. Clearly, the actual available price at that time was below $88.11 a share. In reality because of round-off error, I was charged a higher price, so I paid an extra fee of more than 15 cents a share. That 15 cents is larger than the bid/ask spread.

I get the idea from this thread that folks probably never investigated whether they got a good and fair price when their broker reinvested ETF dividends. With a mutual fund, one is guaranteed to get a fair price: the NAV. I think broker ratings should use the "fairness" of automatic reinvesting of dividends as a rating criteria.

And for some completeness here is the Wiki article listing some pros and cons: Wiki article link: ETFs vs Mutual Funds

Full disclosure: I use ETFs quite a lot.
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trademil
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Re: ETF vs Index Fund

Post by trademil »

livesoft wrote: TDAmeritrade told me that it reinvested BIV for me at a price of $88.259 at 15:51 to 15:53 that day. Clearly, the actual available price at that time was below $88.11 a share. In reality because of round-off error, I was charged a higher price, so I paid an extra fee of more than 15 cents a share. That 15 cents is larger than the bid/ask spread.
What do you mean round-off error?
How can they charge you a different price than the market price? isn't that a fraud? can you sue them?
livesoft
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Re: ETF vs Index Fund

Post by livesoft »

trademil wrote:What do you mean round-off error?
How can they charge you a different price than the market price? isn't that a fraud? can you sue them?
Suppose I get a dividend of $100 and the current price is $88.25, that means I can get $100 / $88.25 = 1.133144 shares, but in reality I get only 1.133 shares because the accounting goes to the nearest thousandth share. That means in reality my price was $100 / 1.133 = $88.2613 per share and not $88.25 per share.

Let me try to make it worse. Suppose I get a $10 dividend, $10 / $88.25 = 0.113 shares and I paid $10 / 0.113 = $88.496 per share. Do you see how $88.496 is larger than $88.25?
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trademil
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Re: ETF vs Index Fund

Post by trademil »

livesoft wrote: Let me try to make it worse. Suppose I get a $10 dividend, $10 / $88.25 = 0.113 shares and I paid $10 / 0.113 = $88.496 per share. Do you see how $88.496 is larger than $88.25?
I would expect them to charge you 88.25$ per share for the 0.113 shares they buy for you, for a total of 9.97225$, lets even call it 9.98$, and put the extra 0.02$ as cash in your account. They did not use those 0.02$ to buy shares for you, right? so they just took them? by what right?
On the other hand, I do not understand how can you buy fractions of shares, so maybe I just got it all wrong...
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Epsilon Delta
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Re: ETF vs Index Fund

Post by Epsilon Delta »

livesoft wrote:
trademil wrote:What do you mean round-off error?
How can they charge you a different price than the market price? isn't that a fraud? can you sue them?
Suppose I get a dividend of $100 and the current price is $88.25, that means I can get $100 / $88.25 = 1.133144 shares, but in reality I get only 1.133 shares because the accounting goes to the nearest thousandth share. That means in reality my price was $100 / 1.133 = $88.2613 per share and not $88.25 per share.

Let me try to make it worse. Suppose I get a $10 dividend, $10 / $88.25 = 0.113 shares and I paid $10 / 0.113 = $88.496 per share. Do you see how $88.496 is larger than $88.25?
You have to know the round off rules and it may not be obvious looking at just one account. Some round off rules will accumulate the extra shares (0.000144 shares in this case) until they get a whole .001 of a share to assign to a quasi-random account. If they do something like that then on average you get the right price. I'm not saying they do that, although I know that at one time banks did it that way when allocating interest so that the books balanced to the penny.
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