Where is the big advantage in ETFs?

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livesoft
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Post by livesoft »

Do not forget that admiral shares are available for those with 10 years in the fund and only $50k invested. So it should be quite a while before your admiral shares go to some other share class.

OTOH, a simple conversion from mutual fund share to the ETF share class (if available for that fund) takes care of the expense ratio for you.
livesoft
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Post by livesoft »

DartThrower wrote:But I don't think anyone will be hurt in any meaningful way by ignoring ETFs and doing mutual fund investing the right way. This simplicity has a value.
This is very true. I also don't think anyone will be hurt in any meaningful way by ignoring mutual funds and doing ETF investing the right way. This simplicity has a value.

I own only mutual funds in my Vanguard and Fidelity accounts. I see no reason to use ETFs there. I own only ETFs in my WellsFargo taxable account. I see no reason to use mutual funds there.

There are good reasons to choose one over the other depending on your individual situation. It is not an either/or decision. There are compelling reasons to have both ETFs and mutual funds, or only ETFs or only mutual funds.

Pros of ETFs:
1. Generally lower expense ratios and can purchase less than the minimums needed for some mutual funds.
2. A good broker like WellsFargo or Fidelity make tax-loss harvesting and bookkeeping trivial since one can use specific share id trivially (but they can do this with mutual fund shares as well).
3. Can use limit orders so you know exactly what you are paying.
4. Can purchase during the day at known prices without waiting for the close of the market session.
5. Asset classes available that an entity like Vanguard does not have in their mutual funds.
6. One can take advantage of occasional anomalies and purchase shares at a lower than expected price.
7. No frequent trading restrictions.

Cons of ETFs:
1. Some brokers charge a commission. Not a problem with brokers which do not charge a commission.
2. The bid-ask spread confuses some people, but we have seen it can be small or one can be taken advantage of.
3. No real way to get a fair price when the market is closed.
4. Must buy integral number of shares ... cannot typically buy fractional shares (though some brokers allow this, but they are not no-commission brokers).
5. Automatic investment is problematic. Your broker may have this functionality, but would you trust their prices? (Do not confuse automatic investment with automatic re-investment of distributions.)
6. Some possible friction when tax-loss harvesting since one usually sells one fund and then buys another. (It is possible to buy first and double-up, then sell later. This can be done with mutual funds as well.)
7. One can stupidly submit orders to sell when the market is closed or use stop-loss orders that get taken advantage of. Or one can make other errors entering orders.

Pros of mutual funds:
1. Can buy fractional shares; all your money goes into shares without leftovers.
2. Automatic investment is easy.
3. Trades execute at end-of-day net asset value.
4. Exchange from one fund to another has no friction since both sell & buy done at end-of-day NAV.
5. Can submit orders when the market is closed. You will get a fair price at the next available NAV.
6. Dividends re-invested the same day they are paid at NAV.

Cons of mutual funds:
1. Expense ratios can be (not always) higher than corresponding ETF.
2. No intraday transactions.
3. Lack of some asset classes without excessive fees.
4 Some funds have trading restrictions (cannot re-buy after selling for NN days).

Both mutual funds and ETFs allow free automatic re-investment of distributions. It is really a broker function --- not a function of the investment.

Both ETFs and mutual funds can be tax efficient ... or not.

Each investor will need to assign value to the advantages important to them and subtract value of the disadvantages important to them. ETFs are not a slam dunk. Neither are mutual funds.

One should not fear either investment vehicle. You can lose money with both of them.

[Edit to add]
Mutual fund transactions settle in T+1, that is the next day after the trade date. ETF transactions settle in T+3 like stocks, that is 3 days later. This difference can have consequences. For example, if one needs cash, then the cash will be available the next day with a mutual fund sell or possible even directed directly to one's checking account. In contrast with the sell of ETF shares, the cash will not be available until 3 days later for transfer out of one's brokerage account. Or at Vanguard if one sells ETF shares and wants to purchase mutual fund shares, then the money from selling the ETF shares may not be available until 3 days later. This may be a problem for folks who use a tiered emergency fund with ETFs because it will take longer to get access to cash from selling ETFs (unless perhaps one has a margin account).

Although automatic dividend re-investment is available with mutual funds and ETFs, the mechanism is slightly different. For mutual fund shares, the distribution is re-invested at the NAV on the same day it is paid. However, for ETFs, the distribution is re-invested at a day, time, and price determined by one's broker. Usually, these are reasonable, but different brokers can do this a day or two differently.

Bond funds and bond ETFs pay dividends differently. With a bond fund paying monthly dividends, the dividend is accrued separately, so if one sells shares of a bond fund, they will get the accrued monthly dividend up to that day. Or if they buy shares, they will get the accrued dividend from that day to the month end. With these dividends accrued separately, there is no change in NAV just because of the monthly dividend (That is NOT the case for a capital gain distribution!)

However, with a bond ETF, the dividend is paid out like a stock dividend. The price of a share of a bond ETF goes "ex-dividend" and drops when one is not going to get the dividend. The monthly dividend usually appears a few days after the end of the month and if automatically re-invested would get re-invested then a few days after the bond mutual fund dividend would be re-invested.
Last edited by livesoft on Sun Jul 14, 2013 2:21 pm, edited 2 times in total.
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DartThrower
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Post by DartThrower »

livesoft wrote:
Cons of mutual funds:
1. Expense ratios can be (not always) higher than corresponding ETF.
2. No intraday transactions.
3. Lack of some asset classes without excessive fees.
That's a small list indeed.

Solutions:

1. Make low cost an absolute requirement for any fund you buy.

2. Why care about intraday transactions? The only reason I can think of is speculation, and investors don't need to speculate to do well.

3. This point has some merit. ETFs will have done a service to investors if they enable the discovery of new asset classes that can be made available at low cost. I just have to wonder what is special about an ETF that allows this vehicle to offer some classes at a meaningfully lower cost, and will competition eventually eliminate these cost differences?
Our patience will achieve more than our force. -Edmund Burke
livesoft
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Post by livesoft »

DartThrower wrote:That's a small list indeed.
Yes, indeed.

It remains to be seen if ETFs remain the fad that they are now or become much more mainstream. The true test is in a few years, when someone posts a new thread asking, "How do I buy regular mutual funds? I'm so used to ETFs, it seems that mutual funds are way too complicated for me."
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ruralavalon
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Post by ruralavalon »

livesoft wrote: It remains to be seen if ETFs remain the fad that they are now or become much more mainstream. The true test is in a few years, when someone posts a new thread asking, "How do I buy regular mutual funds? I'm so used to ETFs, it seems that mutual funds are way too complicated for me."
Exactly right. I do wonder if my reluctance to use ETFs (i.e. my "why bother" conclusion) is mostly a reflection of my familiarity and comfort level with regular mutual funds.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started
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Post by LadyGeek »

I added a wiki link back to this thread, which points to livesoft's list.

Please see Exchange Traded Funds on the Bogleheads Wiki.
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2b2
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Post by 2b2 »

Does anyone else think some of the increased volatility we are seeing in the equity markets is the result of the increased popularity of ETFs ?
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joe8d
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Post by joe8d »

Does anyone else think some of the increased volatility we are seeing in the equity markets is the result of the increased popularity of ETFs ?
Yes and that's what scares me about them.
All the Best, | Joe
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Post by 2b2 »

Ditto.
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