A growing number of mutual fund investors are wondering whether it makes sense to trade their mutual funds in for exchange-traded funds (ETFs). There are many advantages for making the switch, for example, intraday liquidity, lower tax liabilities, and lower annual expense ratios.
What about shareholders in Vanguard's index mutual funds? Is it best to convert those mutual fund shares to Vanguard ETFs that track them same index or leave it?
Here's the low down on Vanguard mutual fund to Vanguard ETF conversions:
Fees for Converting Shareholders of Vanguard stock index funds that offer Vanguard ETFs may convert their conventional shares to Vanguard ETFs of the same fund. For instance, a shareholder who owns the Vanguard Total Stock Market Index Fund Investor Shares (Nasdaq: VTSMX - News) could convert to the Vanguard Total Stock Market ETF (NYSEArca: VTI - News).
There is no fee for Vanguard Brokerage clients to convert conventional shares to Vanguard ETFs of the same fund. Other brokerage providers may charge a fee for the conversion.
Tax Consequences When you convert from the Vanguard mutual fund shares to Vanguard ETFs, the conversion is generally tax-free. When might there be a possible tax? Some brokerage firms may be unable to convert fractional mutual fund shares, which could result in a potential taxable gain.
Four of Vanguard's bond ETFs - the Total Bond Market (NYSEArca: BND - News), Short-Term Bond (NYSEArca: BSV - News), Intermediate-Term Bond (NYSEArca: BIV - News), and Long-Term Bond (NYSEArca: BLV - News) do not allow the conversion of bond index fund shares to bond ETF shares of the same fund, however, the other eight Vanguard bond ETFs allow conversions.
Also keep in mind that your share class conversions are irrevocable. Once you convert from conventional shares to Vanguard ETFs, you cannot convert back to conventional shares. Conventional shares held through a 401(k) account cannot be converted to Vanguard ETFs.
For cost sensitive investors, the low fees in Vanguard ETFs are hard to beat. The Vanguard Emerging Markets Stock Index Fund Investor Shares (Nasdaq: VEIEX - News) charges annual expenses of 0.35% compared to the Vanguard Emerging Markets ETF (NYSEArca: VWO - News), which charges just 0.22%. At face value, these cost differences may seem small, but they add up over the years.
Another advantage of the Vanguard ETF share class is no onerous redemption charges. VEIEX charges a purchase fee of 0.25% and a redemption fee of 0.25% whereas buying VWO only incurs a brokerage commission charge. And if your brokerage account is held at Vanguard, there is no commission charge for trading VWO.
Conclusion While I deeply admire John Bogle, Vanguard's founder, I do not share his radical view that ETFs are a sub-standard or faulty choice. ETFs are a contemporary extension of the indexing trend he started in the 1970s.
Personally, I think the ETF share class offers Vanguard investors much more flexibility. Assuming your Vanguard ETFs has underlying options, you can hedge your ETF shares with put options or sell covered calls to generate additional monthly income. You cannot execute these strategies with Vanguard's mutual fund share class.
Here's another thing: When it comes to selling your ETF shares - you can determine the price you want to sell them at by placing limit orders. You cannot do this with mutual funds, because you never know the exact price at which your mutual fund trades are going to settle at - because it's determined by the fund's net asset value (NAV), which is calculated by the fund company after the market closes.
Ron DeLegge is the Editor of ETFguide.com and Author of 'Gents with No Cents: A Closer Look at Wall Street, its Customers, Financial Regulators, and the Media' (Half Full Publishing, 2011).
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