Does An All ETF Portfolio Make Sense?

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Rick Ferri
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Does An All ETF Portfolio Make Sense?

Post by Rick Ferri »

One frequently asked question I hear is "Should I buy ETFs or mutual funds?" That's the wrong question to ask when building a portfolio, at least not at the beginning. In fact, the process of portfolio construction shouldn't reach the question of buying ETFs or mutual funds or both until the very end.

I recently wrote in the WSJ Experts blog that building a portfolio begins with first deciding on a broad asset-class allocation based on individual needs. The next step is to analyze indexes that track each desired asset class, and decide which ones in what proportions best suit the desired portfolio. After target indexes are selected, research the products that track them. Sometimes these products exist as mutual funds, sometimes they’re ETFs and sometimes they’re available in both.

Once you have a list of potential funds as described, analyze the candidates for differentiating qualities such as cost, diversification and tax efficiency. After all the work is done, don’t be surprised if your portfolio should include both mutual funds and ETFs. There is no good reason to exclude one or the other. A mixture of low-cost, passively managed mutual funds and ETFs is a perfectly fine portfolio.

Read the full WSJ article: Do ETF-Only Portfolios Make Sense?

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Re: Does An All ETF Portfolio Make Sense?

Post by nisiprius »

Rick, to most Bogleheads mutual funds and ETFs look virtually equivalent. It's interesting to me that livesoft and I agree almost perfectly on this--the choice is entirely a matter of personal taste, fee structure at your brokerage, and previous experience in stock transactions--even though he personally prefers ETFs and I personally prefer mutual funds!

Given this, what would be your explanation for the deafening volume of hype surrounding ETFs... people like Ric Edelman saying things like retail mutual funds are dinosaurs and will not exist in 10 years?

He said the same thing as early as 2011 so we are four years into the prediction, with six left to go.

What's driving the seeming excitement, and :twisted: what do you think of Edelman's comment?
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Re: Does An All ETF Portfolio Make Sense?

Post by anil686 »

I am too busy at work during the day (typically) to sit down and purchase ETFs. I love the automatic investment option of mutual funds and can place trades for them anytime (i.e. at night) and have them executed at the end of the next day. But to each their own - we (as investors) are lucky to have both low cost options IMO...
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Re: Does An All ETF Portfolio Make Sense?

Post by HongKonger »

When all you have is access to ETFs, yup, it does.
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Re: Does An All ETF Portfolio Make Sense?

Post by baw703916 »

nisiprius wrote:the deafening volume of hype surrounding ETFs...
You appear to have forgotten the "tune out the noise" part of the Boglehead dogma! ;)
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Re: Does An All ETF Portfolio Make Sense?

Post by Rick Ferri »

nisiprius wrote:.. people like Ric Edelman saying things like retail mutual funds are dinosaurs and will not exist in 10 years...

What's driving the seeming excitement, and :twisted: what do you think of Edelman's comment?
It's an absurd quote. First off, ETFs are mutual funds. There are no ETF filings with the SEC. There are only mutual fund filings that ask for regulatory relief from current mutual fund rules. For example, mutual funds cannot create and redeem shares during the day so firms that issue ETFs need an exemption from that rule.

To say ETFs are "better" than mutual funds has no basis in fact. There are some tax benefits for some ETFs and not for others, and there is the ability to trade during the day at whatever the market price is rather wait and receive NAV pricing on mutual funds at the end of the day, but these do not make ETFs a superior delivery vehicle for all investments in a portfolio.

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Re: Does An All ETF Portfolio Make Sense?

Post by MrNewEngland »

I view them as basically the same (I buy and hold) but I have always had a question and hopefully it can be answered here:

When looking at Vanguard MF/ETFs I noticed that the ETFs always significantly lower expense ratios. Why is that? Am I missing something?
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Re: Does An All ETF Portfolio Make Sense?

Post by baw703916 »

MrNewEngland wrote:I view them as basically the same (I buy and hold) but I have always had a question and hopefully it can be answered here:

When looking at Vanguard MF/ETFs I noticed that the ETFs always significantly lower expense ratios. Why is that? Am I missing something?
Vanguard's ETFs generally have the same E/R as Admiral shares. Although there are some instances of funds (e.g. FTSE smallcap) where there are no Admiral shares, so ETFs are the cheapens option.
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Re: Does An All ETF Portfolio Make Sense?

Post by pshonore »

anil686 wrote:I am too busy at work during the day (typically) to sit down and purchase ETFs. I love the automatic investment option of mutual funds and can place trades for them anytime (i.e. at night) and have them executed at the end of the next day. But to each their own - we (as investors) are lucky to have both low cost options IMO...
I seem to remember that VG does not allow cancellation of mutual fund orders once they are placed. I certainly would not want to place an order a day ahead of time it that is still true.
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Re: Does An All ETF Portfolio Make Sense?

Post by Clive »

MrNewEngland wrote:I view them as basically the same (I buy and hold) but I have always had a question and hopefully it can be answered here:

When looking at Vanguard MF/ETFs I noticed that the ETFs always significantly lower expense ratios. Why is that? Am I missing something?
ETF's tend to benchmark to the net version of a index. Take for instance a 3-fund portfolio that holds VGTSX. Expense Ratio 0.22%, that the factsheet indicates benchmarks to "Spl Total International Stock Index" - but where in the small print (footnotes) it indicates : Spl Total International Stock Index: Total International Composite Index through ... blah blah blah ... Benchmark returns are adjusted for withholding taxes

So in effect a typical investor might look at historic performance and see how closely that compared to the benchmark and feel comfortable that historically x has provided y reward and might continue to do so and my investment will track that relatively closely given the relatively small yearly fund expense cost.

Different countries apply different rates of withholding taxes. The default rate for the US for instance is 30%. Broadly however you might assume a 15% rate as a fair ballpark guide for average withholding taxes.

VGTSX indicates a recent 2.69% dividend yield, from which the funds expenses are typically taken, so 2.69 + 0.22 = 2.91%. If that 2.91% is after 15% average withholding taxes the pre-withholding tax dividend was around 3.42%. So in effect after fund expense and withholding taxes a difference of 3.42 - 2.69 = 0.73%.

If a investor pays say a 20% tax on a 2.69% dividend, then that eats another 0.538% into their investment reward. They might reinvest the dividend and assuming a $100,000 stake in that fund the $2690 dividend less 20% tax = $2152 dividend reinvested, spread over perhaps quarterly payments and $10 broker fee knocks another $40 off that ($2112 of stock bought). And the market maker will take a cut out of that via the bid/ask spread, for a liquid stock/fund perhaps relatively little, maybe just a couple of dollars ($2110 reinvested).

On a $100,000 investment, that paid a $3420 dividend, with dividends reinvested added $2110, a difference of $1310 (1.3%). Maybe after twenty years of a investor having invested in a relatively low cost ETF fund they might be wondering how their investment is showing a lag of nearly 30% below the mathematical (gross) total return "Index" when the ETF's ER indicated that they should perhaps only have lagged the index by around 4.5% in total after accounting for the funds 0.22% yearly expense.

And Vanguard is one of the better providers (operate on a not for profit type basis where investors are the shareholders). Other funds that are more commercial might exploit investors more.

"Investors like dividends" is a widely stated "fact". Not this investor. Yes the taxman, brokers, market makers et al might all like dividends for the regular revenue that provides them, to the extent that they strive to convince investors that dividends are a good thing, perhaps even citing how gross (mathematical) index gains relatively outperformed non dividend payers historically as a reason why a investor should love dividends. Avoiding all the mice nibbling away at investment rewards however and compounding those savings is a primary reason why personally I think ETF's are a fad that is presently peaking but will come to pass. Another ten years and perhaps investors will again be buying/holding diverse ranges of individual stocks, perhaps even preferring non dividend stocks.
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Re: Does An All ETF Portfolio Make Sense?

Post by Vega »

Some ETF benefits: can execute orders mid-day.
May trade at a discount to NAV due to institutional short selling/intraday panic.

Some benefits of funds: you cant sit there and watch your fund zig and zag +/- 1% you only get price updates once per day in the evening. Make it easier to stay the course, psychologically speaking.
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Re: Does An All ETF Portfolio Make Sense?

Post by Clive »

Different countries apply different rates of withholding taxes. The default rate for the US for instance is 30%. Broadly however you might assume a 15% rate as a fair ballpark guide for average withholding taxes.
Much of withholding taxes will depend where the fund is domiciled and what tax treaties may exist with the countries in which stocks are being bought/held. Using this as a example http://www.investlithuania.com/wp-conte ... s-2015.pdf indicates that in some cases France levies a 75% withholding tax rate upon non-cooperative countries.

Looking down VGTSX's country weightings

Code: Select all

	Weight %	Withholding tax rate
Japan	16.8	20.00%
UK	14.3	0
Canada	6.7	25.00%
Germany	6.3	25.00%
Switzerland	6.1	35.00%
France	6.1	30.00%
Australia	6.1	30.00%
China	4.7	10.00%
Korea	3.2	20.00%
Taiwan	3.1	20.00%
It looks like 73.4% of the total weightings are shown and that on a weighted basis amount to a 14.1% average withholding.

Worth noting that withholding taxes might also be being applied to Bond interest i.e. a global bond fund could be benchmarking to bond yields that are lower than gross bond yields after withholding taxes on interest is considered.
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Re: Does An All ETF Portfolio Make Sense?

Post by Clive »

Some ETF's 'lend' stock. If another party can receive a dividend more tax/cost efficiently than the fund then a fund might lend stock to that party just prior to x-div and have the stock returned again on the x-div day, perhaps under agreement of the lending rate being the same as the (more tax efficient) net dividend value (less a 'fee'). Such lending however introduces counter party risk.
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Re: Does An All ETF Portfolio Make Sense?

Post by jhfenton »

I'm currently all ETFs outside of 401(k)s and my HSA. But that is entirely, as nisiprius mentioned, due to the fee structure at TD Ameritrade. Once/if I start to open/move accounts at/to Vanguard, I expect I will end up with a mix of ETFs and traditional MFs. If I were starting from scratch with cash at Vanguard, I'd probably go mostly with traditional MFs in our retirement accounts, simply for the ease of managing monthly new IRA investments. Right now, we have $18.92, $5.40, $4.48, and $0.01 cash available in our Roth and rollover IRAs because the amounts are too small to buy a single share of the lowest-priced ETF (currently VEA at $39.04 or VWO at $39.13). I would probably stick with VSS, however, because of the lack of Admiral shares for Vang FTSE ex-US Small Cap. And in our taxable account, we never have the stray cash problem because I simply transfer cash from checking after placing trades.
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Re: Does An All ETF Portfolio Make Sense?

Post by abuss368 »

Rick Ferri wrote:
nisiprius wrote:.. people like Ric Edelman saying things like retail mutual funds are dinosaurs and will not exist in 10 years...

What's driving the seeming excitement, and :twisted: what do you think of Edelman's comment?
It's an absurd quote. First off, ETFs are mutual funds. There are no ETF filings with the SEC. There are only mutual fund filings that ask for regulatory relief from current mutual fund rules. For example, mutual funds cannot create and redeem shares during the day so firms that issue ETFs need an exemption from that rule.

To say ETFs are "better" than mutual funds has no basis in fact. There are some tax benefits for some ETFs and not for others, and there is the ability to trade during the day at whatever the market price is rather wait and receive NAV pricing on mutual funds at the end of the day, but these do not make ETFs a superior delivery vehicle for all investments in a portfolio.

Rick Ferri
Hi Rick,

Thank you for that explanation. I understand ETF's much better.
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Re: Does An All ETF Portfolio Make Sense?

Post by goingup »

pshonore wrote:
anil686 wrote:I am too busy at work during the day (typically) to sit down and purchase ETFs. I love the automatic investment option of mutual funds and can place trades for them anytime (i.e. at night) and have them executed at the end of the next day. But to each their own - we (as investors) are lucky to have both low cost options IMO...
I seem to remember that VG does not allow cancellation of mutual fund orders once they are placed. I certainly would not want to place an order a day ahead of time it that is still true.
Some unconcerned folks like me set up automatic exchanges to take place on the same day each month regardless of what the market is doing. I've been doing this for 15 years and it has worked out pretty well. :wink:
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Re: Does An All ETF Portfolio Make Sense?

Post by abuss368 »

Hi Rick,

Thank you for sharing.

Best.
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Re: Does An All ETF Portfolio Make Sense?

Post by fidobogo »

All other things being equal (strategy of the fund, expense ratio, volume, etc.), I prefer ETFs, because ETFs let me buy and sell with limit orders.

I like knowing what price I'm going to get in the next few days, and also being able about to fire-and-forget an "offer" to be either "accepted" or not within the next month. The majority of time, this has worked to my advantage. (Nope, I'm not entirely based on AA and zero market timing.)
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Re: Does An All ETF Portfolio Make Sense?

Post by ogd »

fidobogo wrote:All other things being equal (strategy of the fund, expense ratio, volume, etc.), I prefer ETFs, because ETFs let me buy and sell with limit orders.

I like knowing what price I'm going to get in the next few days, and also being able about to fire-and-forget an "offer" to be either "accepted" or not within the next month. The majority of time, this has worked to my advantage. (Nope, I'm not entirely based on AA and zero market timing.)
Yes, this is market timing. Do you also sell stuff that you might also think will available at a lower price within the next month? Do you properly count the times this hasn't worked to this advantage -- as a straight-up 5% loss, let's say, if the price of an asset you should have bought ran away from you?

I don't like long-term limit orders one bit. So suppose next week something really bad happens and the entire market drops 10%. Does your limit order for a stock or sector ETF still make sense, just as it's being executed? You might actually get a bad price in that context, i.e. pay a large premium because it was a weird time in the ETF lifecycle. I view limit orders, for an investor like me, as entirely a way to get around short-term problems inherent to ETFs and market liquidity.

Oh, and don't even get me started on long term so-called "stop loss" orders.
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Re: Does An All ETF Portfolio Make Sense?

Post by fidobogo »

For buying and selling on the same day or three, I much prefer to use limit orders to get a good price for the period, and to have a known limit. If the market moves outside of the noise in the wrong direction, I'm willing to lose the order, and to have to reassess and take further action manually. (I'm not going to mess with complex conditional orders, nor anything fancier than simple price limit orders.)

Contrast with mutual funds, for which, the day I decide I want to make the order, I'm gambling with whatever manipulation and/or dumping/panic/mania of others might happen shortly before market close on that day.

Separately, regarding longer-term limit orders, I agree that they can be dangerous. I've only used them in special cases, and it's not relevant to Bogleheads.
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Re: Does An All ETF Portfolio Make Sense?

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fidobogo wrote: Contrast with mutual funds, for which, the day I decide I want to make the order, I'm gambling with whatever manipulation and/or dumping/panic/mania of others might happen shortly before market close on that day.
Several observations:

1) There's no way to make wiser decisions than whatever happens. If so, you could simply take the other side and get rich. You're not rich (from daily timing, that is).
2) The market has no way of knowing whether you're buying or selling. Statistically, it should help just as often as hurt.
3) Mutual funds are very good at buying at selling stuff. So much so that Vanguard's index funds (the big ones I care about) track their index (which doesn't have to do any trading) by less than the measly expenses. They are better at it than you are at buying ETFs, for sure.
fidobogo wrote:For buying and selling on the same day or three, I much prefer to use limit orders to get a good price for the period, and to have a known limit. If the market moves outside of the noise in the wrong direction, I'm willing to lose the order, and to have to reassess and take further action manually. (I'm not going to mess with complex conditional orders, nor anything fancier than simple price limit orders.)
Three days is already too long for my nose, see post above about the market dropping 10% and your limit order being potentially just as bad of a deal in that context as an overnight market trade (a bad idea because of how ETFs work, and how market opens work).

I also have the feeling that you're not penalizing yourself for losing the order and are too optimistic about the merits of "reassess and take further action manually". If the price ran away 5%, you've lost that much due to your limit order. Count it.

I just want to make it clear that IMHO limit orders, for a buy and holder and non-market-timer (at least at the daily level or less) are not a feature of ETFs, they're a bug. I.e. the fact that you have to use them to get the fair deal that mutual funds give you without any fuss.
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Re: Does An All ETF Portfolio Make Sense?

Post by ogd »

Rick Ferri wrote:
nisiprius wrote:.. people like Ric Edelman saying things like retail mutual funds are dinosaurs and will not exist in 10 years...

What's driving the seeming excitement, and :twisted: what do you think of Edelman's comment?
...
To say ETFs are "better" than mutual funds has no basis in fact. There are some tax benefits for some ETFs and not for others, and there is the ability to trade during the day at whatever the market price is rather wait and receive NAV pricing on mutual funds at the end of the day, but these do not make ETFs a superior delivery vehicle for all investments in a portfolio.

Rick Ferri
Furthermore, I predict that when Vanguard's patent expire and other companies can do tax-favorable dual shares, we might see more of a return to MFs, as people investing with other brokers but sick and tired of having to babysit ETFs can use good mutual funds instead.
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Re: Does An All ETF Portfolio Make Sense?

Post by oneleaf »

ETF's are definitely more tedious, when it comes to actually performing the trade. On the other hand, there is something nice about immediately updating my Google Spreadsheet. As many here do, I have a spreadsheet that has up-to-date prices for each ETF or mutual fund, where I enter the number of shares owned rather than the dollar balance. It is nice to be able to execute each trade, update my spreadsheet with the exact number of shares I bought, and immediately see its impact on my asset allocation. Every few months, I go and make several trades with new money and I find the ETF's to be actually easier to trade, update my spreadsheet, and get it done with. With mutual funds, I have to estimate the number of shares I will buy in my spreadsheet to match the dollar amount I am placing my buy/exchange for, and eventually update it the next day or sometime later with the exact number. Once I got used to the slightly tedious mechanics of limit orders, etc, with ETF's, I actually find them advantageous in regards to my workflow in managing my portfolio.
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Re: Does An All ETF Portfolio Make Sense?

Post by kolea »

I say tomato (long o) you say tomato (long a) . Who cares? There are far more important things to worry about than ETF vs, MF. I really doubt that you can go wrong with one vs the other (as long as the MF is from Vanguard). This is like the modern version of the medieval debate on how many angles can fit on the head of a pin.
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Re: Does An All ETF Portfolio Make Sense?

Post by fidobogo »

ogd wrote:
fidobogo wrote: Contrast with mutual funds, for which, the day I decide I want to make the order, I'm gambling with whatever manipulation and/or dumping/panic/mania of others might happen shortly before market close on that day.
...
3) Mutual funds are very good at buying at selling stuff. So much so that Vanguard's index funds (the big ones I care about) track their index (which doesn't have to do any trading) by less than the measly expenses. They are better at it than you are at buying ETFs, for sure.
I was speaking of market blips that (not so unusually) appear at, say, 3pm and disappear at 10am. Wouldn't such a blip affect the price I get on a Vanguard index fund at the end of the day, similar to how it would if I purchased a similar ETF (without limit order) at 3:59pm? This is an honest question; I don't know.

If Vanguard mutual fund pricing handles such a blip in my favor, on average, like I could with an ETF limit order (or better than I could), that would prompt me to consider going back to mutual funds.
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Re: Does An All ETF Portfolio Make Sense?

Post by ogd »

fidobogo wrote:
ogd wrote:
fidobogo wrote: Contrast with mutual funds, for which, the day I decide I want to make the order, I'm gambling with whatever manipulation and/or dumping/panic/mania of others might happen shortly before market close on that day.
...
3) Mutual funds are very good at buying at selling stuff. So much so that Vanguard's index funds (the big ones I care about) track their index (which doesn't have to do any trading) by less than the measly expenses. They are better at it than you are at buying ETFs, for sure.
I was speaking of market blips that (not so unusually) appear at, say, 3pm and disappear at 10am. Wouldn't such a blip affect the price I get on a Vanguard index fund at the end of the day, similar to how it would if I purchased a similar ETF (without limit order) at 3:59pm? This is an honest question; I don't know.

If Vanguard mutual fund pricing handles such a blip in my favor, on average, like I could with an ETF limit order (or better than I could), that would prompt me to consider going back to mutual funds.
I was talking about spreads and trading efficiency, which is something institutional investors are very good at. They also don't have to contend with ETF basket creation / destruction inefficiencies, resulting in small losses to third parties, like you do.

Mutual funds will not do intraday timing for you. The structure pretty much makes this impossible since any profits would be shared with other shareholders not just the ones buying. However, it's a very good bet you can't do it productively either, like I was saying above. This kind of stuff could make you very rich if it worked. The times it does seem to work and you get a lower price will be balanced by the times you have to pay a much higher price because the limit order failed. "Then I won't buy" / "reevaluate" is no consolation -- you've lost the profit that would have been yours if you weren't trying to time.
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Re: Does An All ETF Portfolio Make Sense?

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TwoByFour wrote:I say tomato (long o) you say tomato (long a) . Who cares? There are far more important things to worry about than ETF vs, MF. I really doubt that you can go wrong with one vs the other (as long as the MF is from Vanguard). This is like the modern version of the medieval debate on how many angles can fit on the head of a pin.
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Re: Does An All ETF Portfolio Make Sense?

Post by Rick Ferri »

Whether you use an ETF or mutual fund is something to think about if you're buying municipal bond funds or high yield corporate bond funds. Just say'n :wink:

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Re: Does An All ETF Portfolio Make Sense?

Post by clip651 »

Rick Ferri wrote:Whether you use an ETF or mutual fund is something to think about if you're buying municipal bond funds or high yield corporate bond funds. Just say'n :wink:

Rick Ferri
Rick - Could you elaborate a bit on that, please? As a newbie I know the basic differences of ETFs and mutual funds, but would have to guess which one would be better for those types of bond funds.

thanks,
cj
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Re: Does An All ETF Portfolio Make Sense?

Post by BigJohn »

clip651 wrote:Rick - Could you elaborate a bit on that, please? As a newbie I know the basic differences of ETFs and mutual funds, but would have to guess which one would be better for those types of bond funds.
Read this for a start http://www.rickferri.com/blog/investmen ... t-problem/

Rick can elaborate as needed if things have changes in the two years since he wrote this.
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Re: Does An All ETF Portfolio Make Sense?

Post by clip651 »

BigJohn wrote: Read this for a start http://www.rickferri.com/blog/investmen ... t-problem/

Rick can elaborate as needed if things have changes in the two years since he wrote this.
Thanks, BigJohn, that more than covers my question. :D
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Re: Does An All ETF Portfolio Make Sense?

Post by Leif »

Thanks for the link. Rick's article is a bit confusing, however, since he does not call HYG a bond ETF in the article. I had to check the link.

I read in a book by Dr. Bernstein that he recommends against having bonds as ETF. I have some VTIP ETFs I hold at Fidelity. I guess I could wait out the discount gap, but I'm thinking of just moving those over to Fidelity's short term government Spartan bond mutual fund.
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Re: Does An All ETF Portfolio Make Sense?

Post by kolea »

BigJohn wrote:
clip651 wrote:Rick - Could you elaborate a bit on that, please? As a newbie I know the basic differences of ETFs and mutual funds, but would have to guess which one would be better for those types of bond funds.
Read this for a start http://www.rickferri.com/blog/investmen ... t-problem/

Rick can elaborate as needed if things have changes in the two years since he wrote this.
This quote from the above link tells me I have nothing to worry about, and neither should any boglehead:
Most of the time, there’s nothing wrong with bond ETFs or how they’re priced, as long as you’re not in a big hurry to trade during a big selloff in the market.
We are all "staying the course", right? Nobody here is in a big hurry to sell in a declining market. :)
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Re: Does An All ETF Portfolio Make Sense?

Post by staythecourse »

Let's face it ETF should do the same as mutual funds for the passive, index investor. For those who want to know why ETF hype has increased... it is simple and its called $$$$. The financial industry only makes money with trading and they have realized the popularity of index investing and that it is unlikely to stop. So in the great land of capitalism they do what I would expect any for profit industry to do and that is push an indexed product that can be traded through out the day. It is rather brilliant. Instead of fighting indexing they went with the flow and pumped up the instrument where they still max out their $$$$.

Gotta love Wall Street. If they weren't so successful at fooling the investor it would be funny.

Good luck.
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Re: Does An All ETF Portfolio Make Sense?

Post by longinvest »

TwoByFour wrote: This quote from the above link tells me I have nothing to worry about, and neither should any boglehead:
Most of the time, there’s nothing wrong with bond ETFs or how they’re priced, as long as you’re not in a big hurry to trade during a big selloff in the market.
We are all "staying the course", right? Nobody here is in a big hurry to sell in a declining market. :)
In viewtopic.php?f=10&t=166352 I expressed my view that ETFs are better at protecting long-term investors in turbulent times.

When bond liquidity disappears, buy-and-hold ETF investors don't pay for providing artificial liquidity to traders that want to sell their parts. That's a good thing.

In a bond mutual fund, long-term investors are the one who pay for providing this artificial liquidity. Unfortunately, the exact cost of this is hidden by the net asset value (NAV) calculation, which may or may not represent the real value of the fund because it's near impossible to determine the real value of a bond that doesn't trade. (The exact cost for fund holders is the loss, if any, due to the difference between the calculated NAV used for redemptions and the real NAV, unknown due to illiquidity).*

* If the ratio of redemptions is small, the cost spread across all fund holders should be small. In contrast, the illiquidity cost is completely assumed by an ETF trader and will look big to him. In other words: If 1000 people share a $10 expense, it will cost each person $0.01 and seem small. If a single person assumes the $10 expense, it will look big.

Selling an ETF in an illiquid market can expose one to ugly bid-ask spreads. But, this possibility should have been anticipated when one bought into an asset class that can experience illiquidity. The problem is not with the ETF, it is with the illiquidity of the underlying asset class.
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Re: Does An All ETF Portfolio Make Sense?

Post by ogd »

longinvest wrote: * If the ratio of redemptions is small, the cost spread across all fund holders should be small. In contrast, the illiquidity cost is completely assumed by an ETF trader and will look big to him. In other words: If 1000 people share a $10 expense, it will cost each person $0.01 and seem small. If a single person assumes the $10 expense, it will look big.

Selling an ETF in an illiquid market can expose one to ugly bid-ask spreads. But, this possibility should have been anticipated when one bought into an asset class that can experience illiquidity. The problem is not with the ETF, it is with the illiquidity of the underlying asset class.
Oh, the problem is very much with the ETF structure on top of the illiquidity. It exacerbates the problem immensely.

The difference is between "I need to find something in the portfolio that I can sell at the same kind of price that I'm supposed to use for the NAV [*]" (mutual fund) and "I need to sell everything in this basket, and some of it has no buyers, so I'll need a big profit incentive" (ETF authorized participant). Furthermore, the [*] footnote for the mutual fund is that they can use derivatives to close that gap, whereas ETFs are extremely inflexible in that regard. And furthermore, the MF problem can be improved with more transparent prices, which regulators are looking into for bonds, whereas I don't think the ETF problem can be improved that much, although I've read that some muni ETFs (for example) are better than others due to subtleties I can't remember.

I wish we'd get the Vanguard index munis funds sooner. Then we'd get to see in practice if they lose anything at all compared to their index in turbulent times, even while poorly constructed ETFs like MUB show multi-% discounts. My bet is, probably not. Certainly nothing of the sort is visible in the bond index funds, if we're talking more liquid bonds.

I think liquidity of a bond fund should matter, because one of the things I'm doing with it is selling in turbulent times. You're probably right that it matters less than long-term shareholder losses, but if there's a huge discrepancy in the size and even likelihood of the two kind of losses, the seemingly smaller problem (liquidity) is the one that gets my vote. You might say, like I think you are, that one should simply not sell muni ETFs in turbulent times, but if a muni fund can accomplish that with minimal or no losses, then I count it as a big plus.
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Re: Does An All ETF Portfolio Make Sense?

Post by Rick Ferri »

Vanguard municipal bond funds and high yield bond fund are a better deal than any ETF. Vanguard's active funds are lower cost, have more diversification, and always trade at NAV. They're more an index fund than any index fund on the market (including ETFs that follow indexes).

You've got to go asset class by asset class to make the best investment choice.

Rick Ferri
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Re: Does An All ETF Portfolio Make Sense?

Post by livesoft »

If a bond ETF has issues with not trading at NAV, doesn't that mean that one can go in in times of "stress" and do a little sniping by buying bond ETFs at below market prices? And then later sell when the stress is relieved and maybe put the proceeds in a bond mutual fund? Of course, a problem is where does the money come from to do the initial buying.

But maybe that's what some large well-capitalized players like Renaissance Technologies do? But then, if this phenomenom is so well-known why isn't it arbitraged away?
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Re: Does An All ETF Portfolio Make Sense?

Post by itstoomuch »

Can't you front run an retail index by using an ETF? :confused
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Re: Does An All ETF Portfolio Make Sense?

Post by itstoomuch »

DS(30), does retail Index in his 401k and Roth. ETF in his taxable.
We (65/68) just do retail in the IRA/Roth. We don't do indexes of any type in the trading accounts, within or without IRA/Roth. I tried Indexes in the trading accounts but it became another thing that I had to understand in a short-term trading environment.
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Re: Does An All ETF Portfolio Make Sense?

Post by Kevin M »

livesoft wrote:If a bond ETF has issues with not trading at NAV, doesn't that mean that one can go in in times of "stress" and do a little sniping by buying bond ETFs at below market prices? And then later sell when the stress is relieved and maybe put the proceeds in a bond mutual fund? Of course, a problem is where does the money come from to do the initial buying.
Yes, some of us did exactly this in June 2013, as discussed in this thread: Muni Bond ETFs are breaking - Bogleheads.

The money could come from a traditional muni bond fund, and then as you say, go back into the traditional fund when the disconnect has disappeared.

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