Question:
Our retirement accounts are in Vanguard index funds, predominantly in Total Stock Market Index. We can convert these funds to the corresponding EFTs free of commission. The only cost seems to be a “bid-ask-spread,” which tends to be around 5 basis points to buy and around 5 basis points when we withdraw. However, if my calculations are correct, we’d save 12 basis points per year in annual expenses. We don’t trade in our retirement accounts. They will likely lay dormant for 5 to 11 years. Is this correct, or have I made an amateurish miscalculation? Does this conversion make sense to you?
Answer:
Vanguard offers a program where an investor can transfer assets from a fund holding to an ETF, without paying the trade commissions. ETFs are Exchange-Traded Funds, and like stocks, investors usually pay a per share commission on trades. ETFs trade like stocks throughout the day unlike a mutual fund, where an investor must wait until the end of the day to trade at the fund’s Net Asset Value, or price per share. The per-share value of a fund is computed once a day, based on the closing market prices of the securities in a fund’s portfolio.
What you are trying to do here is save on costs. Vanguard operates in a very cost effective manner. However, this particular fund charges 17 basis points expense ratio, versus the 12 or so for the ETF. Plus you have a bid-ask-spread when purchasing an ETF.
A bid-ask-spread is essentially the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it. This is a true scenario for most exchange-traded securities. Often, you will have to take a lower selling price than you want.
One of the fundamental differences between a fund and an ETF is the premium or discount ETFs can trade at relative to their current price. A fund trades at its net asset value. This happens as a result of supply and demand in the market place. It is foolish to buy an ETF at a premium, but it could make sense if you were able to buy an ETF at a discount.
One item to consider when deciding between holding a fund and an ETF is that ETFs generally run cheaper because there is a difference in trading costs and tax implications.
When the mutual fund sells its holdings to cover the redemptions, this becomes a taxable event to the fund. That is not the case for an ETF; so generally, ETFs are more tax efficient investments.
We feel this trade between the index fund and the index ETF might make sense over the long term. You should save about 1% over the life of your holding period. Generally, we suggest not making this move, because it may not save you that much money. However, that depends on how much money you have invested in the fund. If you are investing hundreds of thousands of dollars instad of thousands, then this makes sense.
Keep in mind, ETF were greatly affected during the market’s Flash Crash on May 6, 2010. If you wanted to sell some ETFs, you could have taken significant losses as their value fluctuates throughout the day. Again, mutual funds waited until the end of the day and traded for their net asset value. There is more market risk in owning an ETF.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
