Index ETF vs mutual fund in a taxable account

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newbie1212
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Joined: Tue Sep 01, 2020 6:50 pm

Index ETF vs mutual fund in a taxable account

Post by newbie1212 »

Hi everyone,

I am a new member here and certainly new to the investing world. Looking for some advice regarding investing in index ETF vs low cost index funds in a taxable account. I have an investment account with Fidelity and planning to invest some money for period of 5-7 years to save up on a down payment for a bigger home as the family grows. My strategy is to start with initial $10K investment and then contribute $1k monthly to reach my goal, assuming 7% return with 80% in index funds and 20% in bonds/cash.

I am unsure which strategy is better suited for me. Based on the research I have done so far, I like index ETF's (VTI, VOO, IVV, ITOT) due to its low ER and tax efficiency. However, I will not be able to have automatic investment in ETF's with my monthly contributions. Also, the dividend payouts is annually so less opportunity for compounding.

With fidelity index funds (FZROX, FXAIX, FSKAX etc), they certainly have low ER, however my understanding is mutual funds are more tax inefficient compared to ETF's particularly in a taxable account with their turnover rate. I am not sure how much of a difference it will make. The funds will allow me to do automatic reinvesting with monthly contributions and with quarterly dividend payouts, there will be a better opportunity for compounding.

Looking to get some suggestions from the group and which investment vehicle seems better in your experience. My apologies for the long post.

Thanks in advance
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grabiner
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Re: Index ETF vs mutual fund in a taxable account

Post by grabiner »

Welcome to the forum!

I would caution against your plan. If you plan to use the money in 5-7 years, there is a significant risk of losing money with investments which are 80% stock, and if that happens, you won't be able to afford the house you want to buy. For this time horizon, it makes more sense to use bonds or CDs, unless you have another source of funds or expect your investment to be much more than you need. (If you expect your investment to be worth $200K, and you only need $100K, you can afford the risk of a stock-heavy investment.)

For the stock investments, if you prefer mutual funds, you can use Vanguard's index funds. (You would want to hold them in a Vanguard account; other brokerages charge fees for buying Vanguard mutual funds.) Since Vanguard's ETFs are a share class of its mutual funds, the mutual funds have the same tax advantage; none of Vanguard's diversified stock index funds has ever distributed a capital gain.
Wiki David Grabiner
000
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Re: Index ETF vs mutual fund in a taxable account

Post by 000 »

I'd prefer an ETF to a proprietary, gimmick, non-transferable, "zero" fund in taxable. The other mutual funds are less bad.

Personally, if a bigger home is a "want" not a "need", I would think 80/20 would not be too risky for me for these funds.
Topic Author
newbie1212
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Joined: Tue Sep 01, 2020 6:50 pm

Re: Index ETF vs mutual fund in a taxable account

Post by newbie1212 »

Thanks all for your response.

I can certainly revisit my asset allocation strategy if the time frame warrants a more conservative approach.

Since I already have an account with Fidelity, I did not specifically include Vanguard's index funds as there is a $75 transaction fee associated with vanguard's funds on fidelity. With monthly investing, this will certainly increase the cost and consequently will lower the returns. I just wanted to see if ETF's in general will be a better investment vehicle in regards to lower fees and tax efficiency as opposed to index funds in a taxable account.

With regards to ETF', is there anyway to automate monthly investment? Are there any downside to dollar cost averaging investing strategy with ETF?
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theRoCK
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Re: Index ETF vs mutual fund in a taxable account

Post by theRoCK »

Unfortunately, though Fidelity has enabled fractional shares, you cannot schedule it for automatic investments but have to make trades via their app (not even online). One way to dollar-cost average ETFs at Fidelity is to set yourself a periodic reminder to make the investments, and then make those purchases for each ETF at the appropriate dollar amount in the app. Not a set-it-and-forget-it method, I know.

If you arent tied to doing it via Fidelity, M1 Finance allows you to set an allocation across multiple ETFs and invest a set amount periodically.

I am looking at both of those options myself and havent settled on which method to use.
sport
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Re: Index ETF vs mutual fund in a taxable account

Post by sport »

To follow up on grabiner's post, it is often suggested that money needed within 5 years should not be invested in the stock market. Some people even say within 10 years. Since you are looking at 5 to 7 years, your strategy is questionable. If you decide to go ahead, after 2 years, your time for using the money would then be only 3 to 5 years, so you would probably want to cash out your stock holdings around that time. If that is true, then it would really be a short term investment not suitable for the stock market. Alternatively, if you wait until you need the money, the market might be down at that time. Do you feel lucky? I would suggest that luck is not a good strategy.
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