Vanguard ETFs Vs Mutual Funds- Friday Q&A Series

Q.

In terms of Vanguard, are the ETFs really any cheaper than an admiral share mutual fund?  I’m not sure the ER could really get any lower than 0.1%. I’d like to get in a pattern where my monthly contributions are being directed into funds on a routine basis. Is a mutual fund better in this regard? I haven’t used ETFs before.  When using Vanguard funds, should I be using the ETFs or traditional mutual funds?

A.


The quick answer is that it doesn’t matter.  Many novice investors who learn a little more about the importance of keeping costs low are shocked to find out they’re paying 2-3% or more per year to invest.  Advisor fees, high mutual fund expense ratios, and poorly disclosed 401K fees can add up quickly.  But once you’re getting expenses down below 0.25%, the law of diminishing returns quickly kicks in.  Since most Vanguard index funds have expense ratios in this range, it just doesn’t matter much whether you use an exchange-traded fund (ETF) or a mutual fund.  I actually use both, depending on the situation.

Where I Use ETFs

I use ETFs in my 401K, which is basically a Charles Schwab brokerage account with an extra $200/year fee.  At Schwab, the Schwab ETFs are traded commission-free, and Vanguard ETFs are subject to a low $8.95/trade fee.  If I used Vanguard mutual funds, I would have to pay $76 each time I bought ($0 to sell).  So for $58 less per round trip, I’m willing to put up with the hassle of using the ETF.

Where I use Mutual Funds

With my personal and spousal Vanguard Roth IRAs, I prefer using the mutual funds.  My account balances qualify for admiral funds, so there’s no difference in expense ratios, and using the funds allows me to buy, sell, and rebalance when markets aren’t open, which is much more convenient for me.

Comparing expenses

Let’s take a look at the actual expense ratio difference between the commonly-used share classes at Vanguard.

Fund Investor Admiral ETF
Total Stock Market 0.18% 0.06% 0.06%
Total International Stock Market 0.22% 0.18% 0.18%
Total Bond Market 0.22% 0.10% 0.10%
REIT Index 0.24% 0.10% 0.10%
Small Cap International Index 0.50% None 0.28%

As you can see, Vanguard sets the admiral and ETF expense ratios at exactly the same level.  The ETFs, however, must be bought and sold on the open market, so there are some bid-ask spreads you are also paying when you buy and sell.  You may also find yourself buying at a higher or lower price during the day than you’d get just putting in a mutual fund buy order which always transacts at the close of day prices.  ETFs give you more control, but also more hassle.


A special case can be made for newer Vanguard funds that don’t have an admiral class yet, or those funds which have a buy/sell fee.  The Small Cap International Index fund, for instance, has no admiral shares AND is subject to a 0.50% buy/sell fee.  For this reason, I’ve moved that fund to my 401K and buy it as an ETF share.  I’d rather pay $8.95 to buy/sell and have half the ongoing expense ratio than pay 0.50% to buy and sell along with an ER of 0.50% each year.

For someone with enough money to get the admiral shares (generally $10K per fund) that wants to minimize hassle, there’s absolutely nothing wrong with using the traditional mutual funds at Vanguard.  It is much easier to automate mutual fund buying than ETF buying so the investor looking to minimize hassle should usually choose the traditional mutual fund.

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Comments

Vanguard ETFs Vs Mutual Funds- Friday Q&A Series — 10 Comments

  1. So many brokerage accounts have “no transaction ETFs” that they are definitely becoming an easy choice.

    Vanguard has all theirs

    Fidelity has a ton of I-Shares ones

    E-Trade has the ones from Wisdomtree and Global X (most of these i dislike)

    But overall once you get your expense ratios under 0.25% i agree that from there you’re just splitting hairs. You’d have to have a TON of money to notice a real difference between 0.06% and 0.12% even if the latter is 2X as “expensive”

  2. What about the tax impacts. I know that mutual funds shove the results through on a yearly basis, and I think ETF’s only tax when sold. If true it could be a large difference in the amount of money you have to invest in taxable accounte. No difference in retirement accounts.

  3. With such a small difference to consider, many people prefer to automate mutual funds because it saves time. For the big players, that time could mean more money than switching over so it makes sense.

  4. Could you explain this statement a bit more, I have a IRA at Vanguard and wasn’t aware of a fee difference with funds vs. ETFs….”If I used Vanguard mutual funds, I would have to pay $76 each time I bought ($0 to sell). So for $58 less per round trip, I’m willing to put up with the hassle of using the ETF….”
    Thanks, Dave

  5. As a resident, I don’t have enough money in my Vanguard Roth IRA to put $10K into all my the funds I’d like to use. I fit into the fund junkie category and like having diversity. The Vanguard ETFs give me the flexibility to put a little money into each of several funds while still getting the cost benefit of Admiral shares. That said, as soon as I have enough money in a fund to buy the Admiral shares, I’ll switch because the ETFs are definitely more time-intensive.

  6. Dave-

    Those are the fees the Schwab brokerage charges to buy Vanguard funds there. Vanguard doesn’t charge those fees if you buy direct from Vanguard.

  7. Just curious and to be sure I understand correctly, you state that for your Roth IRA you prefer Vanguard Mutual Funds. Are you investing the ROTH in the Total Stock Market, Total International Stock Market, Total Bond Market, REIT Index, and Small Cap International Index Mutual Funds?

    • Which asset classes I actually hold in my Roth IRAs right now include (keep in mind it changes frequently as 401Ks change and amounts in each account change):

      Bridgeway Roth IRA: Bridgeway Ultra small market fund

      Lending Club Roth IRA: Lending Club Notes

      My Vanguard Roth IRA: Emerging markets index, small cap international index, REIT index, Total international index funds

      My wife’s Vanguard Roth IRA: Small value index, Large Value index, and Total international index funds

      Everything else in my asset allocation is in the TSP (G, S, I) or my 401K (TSM ETF, Schwab TIPS ETF, and Small cap international ETF).

      You always have to look at your retirement portfolio as a whole. Take the best of what’s in your 401K, then supplement with IRAs.

  8. The term mutual fund is less widely used outside of the United States and Canada. For collective investment vehicles outside of the United States, see articles on specific types of funds including open-ended investment companies, SICAVs, unitized insurance funds, unit trusts and Undertakings for Collective Investment in Transferable Securities, which are usually referred to by their acronym UCITS.::.-

    All the best to you

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