MF to ETF conversion - am I missing anything?

[footballfan82]

Hi everyone!

For a taxable account and an IRA that have contained Vanguard index mutual funds for quite a few years, I've looked at whether it makes sense to go ahead and do the conversion from the VG mutual funds to the corresponding VG ETFs? I've done some basic research, but I'd still like some confirmation that I'm not missing anything critical.

1. From a practical standpoint, would it be accurate to say that VG ETFs are equally as good as the corresponding VG mutual funds? Other than the obvious differences between an ETF and a mutual fund, is there any more subtle reason that someone might want to specifically do the conversion, or not do the conversion?

2. For the VG funds held in the taxable account, the conversion to the corresponding ETF would be tax-free, right? Are there any considerations to watch out for in terms of the timing of the conversion? For instance, for stock funds that will soon be paying out March dividends, does it make sense to wait on the conversion until after the March dividends have been paid, or is it better to do the conversion before the dividends are paid? Or does it not really make a difference either way?

3. Finally, when converting, am I correct in assuming that the number of ETF shares acquired as part of the conversion might be based on an average of the high and low price of the ETF for the day of the conversion? Is there any reason to try to specifically choose one day over another to do the conversion, or is any trading day just about as good as any other?

Thank you for any insights that you have to offer!

[FreddieFIRE]

IIRC, the one time I converted a VG MF to an ETF they mucked up the cost basis. Everything wound up average cost basis instead of the spec lot basis I had and desired.

[footballfan82]

IIRC, the one time I converted a VG MF to an ETF they mucked up the cost basis. Everything wound up average cost basis instead of the spec lot basis I had and desired.

You know, I hadn't even thought about cost basis until you mentioned this! Were they able to fix it for you after the fact? If someone is just using average cost, would you see any concerns about the conversion messing up cost basis? Thanks!

[Epsilon Delta]

I think you should ask "is there any reason to convert MF to ETF?" The only good reason I have seen is to hold Vanguard funds at another brokerage. Is that what you intend to do?

As for 3) the price of the conversion I believe it's a red herring. You convert shares for shares (possible with a constant multiplier). It's not a taxable event, the cost basis should carry over. The price at the conversion is irrelevant.

[sycamore]

1. From a practical standpoint, would it be accurate to say that VG ETFs are equally as good as the corresponding VG mutual funds?

Yes, as a practical matter. The ETF and mutual funds are different share classes in the same investment company.

This means they share the underlying holdings (stocks or bonds) in the same proportion, the holdings' aggregate performance, dividend distributions, capital gains distributions, and tax efficiency.

The two share classes do not usually have the same exact expense ratio, but most ETF/mutual fund pairs have a very small ER difference, e.g., for Vanguard Total Stock Market Index it's 0.04% - 0.03% = 0.01%.

Other than the obvious differences between an ETF and a mutual fund, is there any more subtle reason that someone might want to specifically do the conversion, or not do the conversion?

In general, ETFs are more "portable" between brokerages. You can transfer them with no fee, and subsequently trade them for no commission.

By contrast, the picture is more muddled with mutual funds. AFAIK, most brokerages will accept a transfer of incoming Vanguard mutual funds with no fee. But each brokerage sets its own policy on the sale or purchase of mutual funds. I think E*Trade and Chase do not apply a commission for buying or selling Vanguard MFs. Other brokerages typically charge for buying more shares, but not for selling.

Speaking of account transfers, transfers of a mutual fund usually is for all your shares, both whole and fractional amounts, e.g., 123.456 shares. But with individual stocks and ETFs, the "ACATS" transfer process only allows for the whole share amounts. The small portion, e.g., 0.456, is liquidated/sold and its cash value is transferred.

[sycamore]

As for 3) the price of the conversion I believe it's a red herring. You convert shares for shares (possible with a constant multiplier). It's not a taxable event, the cost basis should carry over. The price at the conversion is irrelevant.

Right.

Vanguard has said that the conversion takes place at Net Asset Value for both share classes.

[simplesimon]

Other than the obvious differences between an ETF and a mutual fund, is there any more subtle reason that someone might want to specifically do the conversion, or not do the conversion?

My favorite explanation of the difference in process in buying an ETF and a mutual fund:

viewtopic.php?p=2312253&sid=d6e8a474339 ... d#p2312253

[FreddieFIRE]

I think you should ask "is there any reason to convert MF to ETF?" The only good reason I have seen is to hold Vanguard funds at another brokerage. Is that what you intend to do?

That is the exact reason I did it years ago.

[FreddieFIRE]

IIRC, the one time I converted a VG MF to an ETF they mucked up the cost basis. Everything wound up average cost basis instead of the spec lot basis I had and desired.

You know, I hadn't even thought about cost basis until you mentioned this! Were they able to fix it for you after the fact? If someone is just using average cost, would you see any concerns about the conversion messing up cost basis? Thanks!

I "think" they were non-covered shares that I ultimately moved to Fidelity. I asked VG to correct the basis, but they just claimed that it was not available (even though I had screen caps from the VG website just days earlier showing the true basis for each lot). I just kept track of the real cost basis myself. Ultimately, I think I wound up donating them to my DAF, so cost basis didn't matter at that point.

[footballfan82]

I think you should ask "is there any reason to convert MF to ETF?" The only good reason I have seen is to hold Vanguard funds at another brokerage. Is that what you intend to do?

As for 3) the price of the conversion I believe it's a red herring. You convert shares for shares (possible with a constant multiplier). It's not a taxable event, the cost basis should carry over. The price at the conversion is irrelevant.

There are two main reasons I've been considering this option. One is exactly the reason you mentioned--that if someone decides to move to another brokerage in the future, it seems like ETFs are the easiest way to accomplish that, right? And the other reason is just the potential for slightly higher returns over time, or possibly some tax savings? It looks to me like at least some of the ETFs have slightly lower expense ratios, and I'd also read that there could be circumstances where a capital gains distribution could be avoided with an ETF compared to the mutual fund? I realize that these small differences might not amount to very much over time, but then I've wondered, if there's no real downside to doing the conversion, does it make sense to go ahead and do it?

Do you think it's better to just stay with the mutual fund instead of converting? Honestly, if brokerages like Schwab or Fidelity can hold existing VG mutual funds, receive and reinvest their dividends, and if you have the option to sell them in the future without fees (or only modest fees), then the only real reason I'd think about a conversion is just for the potential for slightly higher returns over time...

Thank you!

[footballfan82]

1. From a practical standpoint, would it be accurate to say that VG ETFs are equally as good as the corresponding VG mutual funds?

Yes, as a practical matter. The ETF and mutual funds are different share classes in the same investment company.

This means they share the underlying holdings (stocks or bonds) in the same proportion, the holdings' aggregate performance, dividend distributions, capital gains distributions, and tax efficiency.

The two share classes do not usually have the same exact expense ratio, but most ETF/mutual fund pairs have a very small ER difference, e.g., for Vanguard Total Stock Market Index it's 0.04% - 0.03% = 0.01%.

Other than the obvious differences between an ETF and a mutual fund, is there any more subtle reason that someone might want to specifically do the conversion, or not do the conversion?

In general, ETFs are more "portable" between brokerages. You can transfer them with no fee, and subsequently trade them for no commission.

By contrast, the picture is more muddled with mutual funds. AFAIK, most brokerages will accept a transfer of incoming Vanguard mutual funds with no fee. But each brokerage sets its own policy on the sale or purchase of mutual funds. I think E*Trade and Chase do not apply a commission for buying or selling Vanguard MFs. Other brokerages typically charge for buying more shares, but not for selling.

Speaking of account transfers, transfers of a mutual fund usually is for all your shares, both whole and fractional amounts, e.g., 123.456 shares. But with individual stocks and ETFs, the "ACATS" transfer process only allows for the whole share amounts. The small portion, e.g., 0.456, is liquidated/sold and its cash value is transferred.

Yep, it's that small possible advantage in expense ratio, combined with the potential for future portability that has me considering the conversion, IF there's no real catch otherwise in doing so? But if a brokerage like Schwab or Fidelity can hold the VG mutual funds, reinvest dividends, and allow them to be sold in the future, all without fees, then I'm not sure I'd be too bothered personally be holding the mutual funds at another brokerage. If there were a charge just for buying NEW mutual fund shares, I could just make any future new purchases of the ETF instead of the fund. But if ETFs have that tiny ER advantage anyway...

Thank you!!

[footballfan82]

As for 3) the price of the conversion I believe it's a red herring. You convert shares for shares (possible with a constant multiplier). It's not a taxable event, the cost basis should carry over. The price at the conversion is irrelevant.

Right.

Vanguard has said that the conversion takes place at Net Asset Value for both share classes.

Great...I'm glad to not have to worry about the timing aspect! Just to clarify, can I also completely ignore the distribution schedule for the fund/ETF? In other words, could someone cause a problem for themselves by doing the conversion right around quarterly dividend time? When I try to think through it, it doesn't seem to me like that should matter either, but I tend to overthink everything...haha

[footballfan82]

Other than the obvious differences between an ETF and a mutual fund, is there any more subtle reason that someone might want to specifically do the conversion, or not do the conversion?

My favorite explanation of the difference in process in buying an ETF and a mutual fund:

viewtopic.php?p=2312253&sid=d6e8a474339 ... d#p2312253

Thanks, I will check out that thread!

[footballfan82]

You know, I hadn't even thought about cost basis until you mentioned this! Were they able to fix it for you after the fact? If someone is just using average cost, would you see any concerns about the conversion messing up cost basis? Thanks!

I "think" they were non-covered shares that I ultimately moved to Fidelity. I asked VG to correct the basis, but they just claimed that it was not available (even though I had screen caps from the VG website just days earlier showing the true basis for each lot). I just kept track of the real cost basis myself. Ultimately, I think I wound up donating them to my DAF, so cost basis didn't matter at that point.

Glad it didn't end up causing you any grief! If someone mainly just has covered shares, hopefully all cost basis info would transfer with the conversion without issue...

[ee_guy]

Look at the ease/difficulty of selling, for example $100, of a mutual fund vs ETF.

[GaryA505]

About the only downside of converting to ETFs in a taxable account:
If you convert to ETFs you won't be able to use the Vanguard or Fidelity automatic recurring withdrawals in retirement. Currently this only works with mutual funds.

[sycamore]

Right.

Vanguard has said that the conversion takes place at Net Asset Value for both share classes.

Great...I'm glad to not have to worry about the timing aspect! Just to clarify, can I also completely ignore the distribution schedule for the fund/ETF? In other words, could someone cause a problem for themselves by doing the conversion right around quarterly dividend time? When I try to think through it, it doesn't seem to me like that should matter either, but I tend to overthink everything...haha

One thing to know about is if you hold the MF on its record date then you'll receive its dividend. But how will the dividend be dealt with? Will it be reinvested if that was your dividend election? Into which share class? You would never lose out, but you might be left wondering (and worrying) for a few days. To avoid any uncertainty, don't convert around the distribution week.

Also, theoretically, you could convert to an ETF that has its record date after the MF's, and you end up getting both dividends. This would not a problem nor would you be getting an extra dividend for free (the dividend value is embedded in the NAV, so when the dividend is distributed the NAV goes down). It's merely the case that you'd have two separate share lots. Some people don't want more lots than necessary.

Speaking of share lots, make sure you set your cost basis election (on the mutual fund) before converting -- typically SpecID is best as it allows for the most flexibility. And then check the cost basis on the ETF after converting. You may need to set it to SpecID if that election didn't carry over.

[increment]

I'd also read that there could be circumstances where a capital gains distribution could be avoided with an ETF compared to the mutual fund?

ETFs can use special techniques to avoid capital-gain distributions. Vanguard mutual funds that are sibling share classes of ETFs also share that benefit, so in your case there is no advantage (or disadvantage) of the ETF over the mutual fund. (Only Vanguard has been able to open a mutual fund to take advantage of this.)

I realize that these small differences might not amount to very much over time, but then I've wondered, if there's no real downside to doing the conversion, does it make sense to go ahead and do it?

Do you think it's better to just stay with the mutual fund instead of converting? Honestly, if brokerages like Schwab or Fidelity can hold existing VG mutual funds, receive and reinvest their dividends, and if you have the option to sell them in the future without fees (or only modest fees), then the only real reason I'd think about a conversion is just for the potential for slightly higher returns over time...

Some people dislike having to suffer the bid/ask spread when they actually buy and sell.

[talzara]

Some people dislike having to suffer the bid/ask spread when they actually buy and sell.

For the most actively traded ETFs, you will save more on the expense ratio than you pay on the spread.

The Vanguard S&P 500 Index Fund has an expense ratio of 0.04% for the Admiral shares. The ETF (VOO) has an expense ratio of 0.03%. The ETF has a price of $514 and trades at a penny spread. You will earn back the bid-ask spread in 70 days.

If you hold VOO for 30 years, then the lower expense ratio will save you 150 times the bid-ask spread.

[talzara]

As for 3) the price of the conversion I believe it's a red herring. You convert shares for shares (possible with a constant multiplier). It's not a taxable event, the cost basis should carry over. The price at the conversion is irrelevant.

Vanguard has said that the conversion takes place at Net Asset Value for both share classes.

On the day of the conversion, you can think of it as a constant ratio. It doesn't matter if the ETF is trading at a 0.2% premium or a 0.2% discount. You will receive the same number of ETF shares for each mutual fund share.

Over a long period of time, the ratio will change. The expense ratio is different for each share class, so the ratio of NAV per share will change. You may get 1.2345 ETF shares per Admiral share today, but a year later it will be 1.2344 shares if the ETF shares have a 0.01% lower expense ratio.

[Epsilon Delta]

Over a long period of time, the ratio will change. The expense ratio is different for each share class, so the ratio of NAV per share will change. You may get 1.2345 ETF shares per Admiral share today, but a year later it will be 1.2344 shares if the ETF shares have a 0.01% lower expense ratio.

AIUI expenses are taken out of dividends, so different expense rations should not affect the ratio in the long term.

[talzara]

Over a long period of time, the ratio will change. The expense ratio is different for each share class, so the ratio of NAV per share will change. You may get 1.2345 ETF shares per Admiral share today, but a year later it will be 1.2344 shares if the ETF shares have a 0.01% lower expense ratio.

AIUI expenses are taken out of dividends, so different expense rations should not affect the ratio in the long term.

You're right.

VOO has an SEC yield of 1.21%, and VFIAX has an SEC yield of 1.20%. This is exactly the same as the 0.01% difference in expense ratios.

Other ETFs with lower expense ratios also have a higher yield.

Since the expense ratio is taken out of the dividends, not the NAV, why is there a difference in share prices? Why isn't every share class the same price per share? ETFs have a different price, but Investor and institutional shares also have different prices.

[footballfan82]

About the only downside of converting to ETFs in a taxable account:
If you convert to ETFs you won't be able to use the Vanguard or Fidelity automatic recurring withdrawals in retirement. Currently this only works with mutual funds.

Yep, that's definitely one case where the mutual fund currently has an advantage over the ETF. Thanks!

[footballfan82]

Great...I'm glad to not have to worry about the timing aspect! Just to clarify, can I also completely ignore the distribution schedule for the fund/ETF? In other words, could someone cause a problem for themselves by doing the conversion right around quarterly dividend time? When I try to think through it, it doesn't seem to me like that should matter either, but I tend to overthink everything...haha

One thing to know about is if you hold the MF on its record date then you'll receive its dividend. But how will the dividend be dealt with? Will it be reinvested if that was your dividend election? Into which share class? You would never lose out, but you might be left wondering (and worrying) for a few days. To avoid any uncertainty, don't convert around the distribution week.

Also, theoretically, you could convert to an ETF that has its record date after the MF's, and you end up getting both dividends. This would not a problem nor would you be getting an extra dividend for free (the dividend value is embedded in the NAV, so when the dividend is distributed the NAV goes down). It's merely the case that you'd have two separate share lots. Some people don't want more lots than necessary.

Speaking of share lots, make sure you set your cost basis election (on the mutual fund) before converting -- typically SpecID is best as it allows for the most flexibility. And then check the cost basis on the ETF after converting. You may need to set it to SpecID if that election didn't carry over.

I'd definitely want to avoid getting both dividends in the taxable account! But yes, if we decide to go ahead with the conversion, we can make sure to not do it too close to the record date, just for added peace of mind. As long as we don't somehow get both dividends, I guess it's pretty much going to be the same whether we get the mutual fund dividend OR the ETF dividend? Anyway, thanks again, I really appreciate your thoughts on this topic!

[exodusNH]

IIRC, the one time I converted a VG MF to an ETF they mucked up the cost basis. Everything wound up average cost basis instead of the spec lot basis I had and desired.

You know, I hadn't even thought about cost basis until you mentioned this! Were they able to fix it for you after the fact? If someone is just using average cost, would you see any concerns about the conversion messing up cost basis? Thanks!

If you've ever sold shares using average cost, you're locked into it.

If you have shares purchased before companies were mandated to keep track of basis (2012ish), they don't have to keep it even if they already have it.

I converted shares last summer to transfer to Merrill Edge. The cost basis and lots were as expected.

[footballfan82]

I'd also read that there could be circumstances where a capital gains distribution could be avoided with an ETF compared to the mutual fund?

ETFs can use special techniques to avoid capital-gain distributions. Vanguard mutual funds that are sibling share classes of ETFs also share that benefit, so in your case there is no advantage (or disadvantage) of the ETF over the mutual fund. (Only Vanguard has been able to open a mutual fund to take advantage of this.)

I realize that these small differences might not amount to very much over time, but then I've wondered, if there's no real downside to doing the conversion, does it make sense to go ahead and do it?

Do you think it's better to just stay with the mutual fund instead of converting? Honestly, if brokerages like Schwab or Fidelity can hold existing VG mutual funds, receive and reinvest their dividends, and if you have the option to sell them in the future without fees (or only modest fees), then the only real reason I'd think about a conversion is just for the potential for slightly higher returns over time...

Some people dislike having to suffer the bid/ask spread when they actually buy and sell.

Oh, so the VG ETF would NOT have any advantage over the VG mutual fund in terms of capital gain distributions? Interesting...thanks!!

[footballfan82]

Some people dislike having to suffer the bid/ask spread when they actually buy and sell.

For the most actively traded ETFs, you will save more on the expense ratio than you pay on the spread.

The Vanguard S&P 500 Index Fund has an expense ratio of 0.04% for the Admiral shares. The ETF (VOO) has an expense ratio of 0.03%. The ETF has a price of $514 and trades at a penny spread. You will earn back the bid-ask spread in 70 days.

If you hold VOO for 30 years, then the lower expense ratio will save you 150 times the bid-ask spread.

Thank you! This is a really helpful example!

[footballfan82]

As for 3) the price of the conversion I believe it's a red herring. You convert shares for shares (possible with a constant multiplier). It's not a taxable event, the cost basis should carry over. The price at the conversion is irrelevant.

Vanguard has said that the conversion takes place at Net Asset Value for both share classes.

On the day of the conversion, you can think of it as a constant ratio. It doesn't matter if the ETF is trading at a 0.2% premium or a 0.2% discount. You will receive the same number of ETF shares for each mutual fund share.

Over a long period of time, the ratio will change. The expense ratio is different for each share class, so the ratio of NAV per share will change. You may get 1.2345 ETF shares per Admiral share today, but a year later it will be 1.2344 shares if the ETF shares have a 0.01% lower expense ratio.

I'm glad to hear that the conversion is done in such a way that we wouldn't have to worry about whether there is a premium or a discount on the ETF at the time of the conversion... Thanks again!

[footballfan82]

You know, I hadn't even thought about cost basis until you mentioned this! Were they able to fix it for you after the fact? If someone is just using average cost, would you see any concerns about the conversion messing up cost basis? Thanks!

If you've ever sold shares using average cost, you're locked into it.

If you have shares purchased before companies were mandated to keep track of basis (2012ish), they don't have to keep it even if they already have it.

I converted shares last summer to transfer to Merrill Edge. The cost basis and lots were as expected.

I will double check, but one of the holdings might actually be locked into average cost... Thanks!

[Claudia Whitten]

IIRC, the one time I converted a VG MF to an ETF they mucked up the cost basis. Everything wound up average cost basis instead of the spec lot basis I had and desired.

That's horrible.

I don't like ETFs. They're extra work to buy (bid/ask) and sell, and you end up with cash turds in your account because you can't invest whole amounts. Plus they trade throughout the day, so you're tempted to peek. Or I am.

OP: why are you converting?

[sycamore]

...As long as we don't somehow get both dividends, I guess it's pretty much going to be the same whether we get the mutual fund dividend OR the ETF dividend?

Correct.

One minor difference concerns dividend reinvestment . With the mutual fund, it's reinvested at Net Asset Value. But which day's NAV depends on the brokerage. With Vanguard it's the payable date I believe.

With ETFs, it's up to the brokerage as to when they purchase shares using the distribution money. Each brokerage has its own process. Maybe the shares are bought at market open on the next day? Or at 10:00 on the second next day, or some other day/time.

These differences have more to do with the brokerage than anything else. But it's another thing to be aware of if you're simply used to the way things work with mutual funds at Vanguard.

[increment]

The Vanguard S&P 500 Index Fund has an expense ratio of 0.04% for the Admiral shares. The ETF (VOO) has an expense ratio of 0.03%. The ETF has a price of $514 and trades at a penny spread. You will earn back the bid-ask spread in 70 days.

If you hold VOO for 30 years, then the lower expense ratio will save you 150 times the bid-ask spread.

Is a penny typical? It looks like now (in the middle of the trading day) the spread is 4 cents (says Vanguard), or 5 cents (Fidelity) or 15 cents (Yahoo). Vanguard's VOO info page says that the median spread is 0.01% (or 5 cents). But, as you say, paying the spread should still win in the long term (over a year).

[PersonalFinanceJam]

Other than the obvious differences between an ETF and a mutual fund, is there any more subtle reason that someone might want to specifically do the conversion, or not do the conversion?

My favorite explanation of the difference in process in buying an ETF and a mutual fund:

viewtopic.php?p=2312253&sid=d6e8a474339 ... d#p2312253

While I'm not sure the OP has a great case for mutual fund to ETF conversion, the linked post above was written 10 years ago. It is becoming hilariously outdated with regard to ETF investing in light of dollar based investing, automatic ETF investing, and the mobile app platforms at many of the major brokerages. Including Vanguard.

[footballfan82]

IIRC, the one time I converted a VG MF to an ETF they mucked up the cost basis. Everything wound up average cost basis instead of the spec lot basis I had and desired.

That's horrible.

I don't like ETFs. They're extra work to buy (bid/ask) and sell, and you end up with cash turds in your account because you can't invest whole amounts. Plus they trade throughout the day, so you're tempted to peek. Or I am.

OP: why are you converting?

Only two reasons the conversion is being considered--the potential ease with which the ETFs could be moved to another brokerage in the future, if desired, and the slightly lower expense ratio that some of the ETFs offer...

[footballfan82]

...As long as we don't somehow get both dividends, I guess it's pretty much going to be the same whether we get the mutual fund dividend OR the ETF dividend?

Correct.

One minor difference concerns dividend reinvestment . With the mutual fund, it's reinvested at Net Asset Value. But which day's NAV depends on the brokerage. With Vanguard it's the payable date I believe.

With ETFs, it's up to the brokerage as to when they purchase shares using the distribution money. Each brokerage has its own process. Maybe the shares are bought at market open on the next day? Or at 10:00 on the second next day, or some other day/time.

These differences have more to do with the brokerage than anything else. But it's another thing to be aware of if you're simply used to the way things work with mutual funds at Vanguard.

Ah, I've wondered about that very thing, even though I realize it might not be anything of consequence in the grand scheme of things! The more responses I get, the more I'm wondering if it makes sense just to keep the mutual funds instead of converting? Especially if a brokerage like say, Schwab, could hold VG mutual funds and reinvest dividends without extra fees (I'll have to call them to ask those questions), then the conversion might just be for the slight difference in expense ratio... Anyway, your help in this thread has been greatly appreciated, so thank you again!!

[endyii]

That's horrible.

I don't like ETFs. They're extra work to buy (bid/ask) and sell, and you end up with cash turds in your account because you can't invest whole amounts. Plus they trade throughout the day, so you're tempted to peek. Or I am.

OP: why are you converting?

Only two reasons the conversion is being considered--the potential ease with which the ETFs could be moved to another brokerage in the future, if desired, and the slightly lower expense ratio that some of the ETFs offer...

Just to tag along from another thread, a person may want to convert since it is easier to hold US ETFs as US citizen in other countries then mutual funds.

[Claudia Whitten]

Only two reasons the conversion is being considered--the potential ease with which the ETFs could be moved to another brokerage in the future, if desired, and the slightly lower expense ratio that some of the ETFs offer...

The first one is a good reason. The second one, nah.