While I touched on it in Part XVII, the differences between ETFs and Mutual Funds is a recurring question here. Perhaps I should have covered it better. Let’s do that now.
We’ll use VBTLX and its ETF version, BND, as examples since those were my choices in my most recent move.
ETFs (Exchange Traded Funds) were created a number of years ago, mostly to facilitate the trading of mutual fund portfolios.
Since this Stock Series and my book are focused on long-term investing rather than trading, I’ve tended to ignore them here. But there are times when they might make sense for you, so let’s take a look.
Here is the most important thing to understand:
VBTLX and BND both hold exactly the same Total Bond Market Index portfolio
This is also true of VTSAX and VTI, and every other mutual fund and its ETF companion.
Compared to the reasons to chose any given portfolio, the differences between funds and ETFs are minor — another reason I’ve not bothered till now to address them.
But they are not nothing, so let’s take a closer look…
—Because ETFs were designed for trading, you can buy as little as one share. As I write, the price of one share of BND is $87.20. VBTLX, on the other hand, requires a minimum $3000 investment to start. So even if you have less than that amount, you can still own the portfolio with the ETF version.
—On the other hand, you cannot buy fractional shares with an ETF. With a mutual fund you can. If you have, say, $5000 to invest, you can put that exact amount into VBTLX. With BND, at the current price of $87.20, you’d buy 57 shares for $4970.40 or 58 shares for $5057.60.
Correction: In the comments below, reader Jon pointed out that most brokerages now accommodate fractional shares when trading ETFs. Vanguard remains an exception, so at least my math didn’t go tatally to waste. 🙂
—When you buy an ETF, you get “real time” pricing, just like buying a stock. The moment you place your order, you get that moment’s price per share. Mutual funds trade at the end of the day and you get the price of the shares at the market’s close. If you place your order at 10am, it is very likely that the price will be slightly up or down by the time the market closes. Personally, I place my fund orders near the end of the day so I have a better read on what the price will be. This is particularly important with stock funds that tend to be more volatile.
—Mutual funds allow for setting up automatic deposits and withdrawals. (These are great tools) ETFs do not.
—ERs (expense ratios) can be slightly different between funds and ETFs. For instance, VBTLX has an ER of .05%. BND’s is .035%.
—There will be a “bid/ask spread” when buying ETFs. These are small costs, but they are not zero. So this one is mostly just FYI. Exactly what they are is beyond the scope of this post and unimportant for its purposes.
—Some brokerages also charge commissions to buy and sell ETFs, but this is less common than it used to be. But check. Paying commissions in this day and age is silly.
—If you work with a brokerage other than Vanguard and you want to buy a Vanguard fund, there are frequently extra trading charges. ETFs are the better choice in this case. This is true in most cases where you are working with one brokerage and buying the funds of another.
For my international readers, AA40 offers this in the comments:
—“With the not-so-new FATCA (Foreign Tax Compliance Act part of the 2010 HIRE Act), many U.S. mutual fund companies have introduced policies preventing their funds from being purchased by non-U.S. residents, including Americans abroad. While this is true for Mutual Funds, ETFs are still widely allowed.”
That’s pretty much it for the major differences. Other readers have offered some interesting additional ones in the comments below.
For me, funds are the better choice and so I tend to talk in terms of VBTLX and VTSAX. For you? That depends on how you value the differences.
Here are some other resources:
- FAQ from Vanguard on ETFs
- Reader Jonathan provides an excellent review of ETFs
- In this comment thread, reader Greg provides a nice comparison of funds vs. ETFs
These might be somewhat redundant with this post, but since they explain things a bit differently they will help if you are still confused.
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This is a great podcast episode from Bigger Pockets:
Early Retirement: Asset Allocation and Safe Withdrawal Rates with Michael Kitces
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Here’s everything you need to know about the 4% Rule:
The 4% rule, withdrawal rates and how much can I spend anyway?
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From my friends Billy and Akaisha, who have been retried and traveling the world for decades now, a beautiful story and lesson…
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