Mailbag: Which is better, Vanguard mutual funds or ETFs?

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Lazo

You recommend exchange traded funds (ETFs) in your gone fishing portfolio. My brother wants to invest in mutual funds and is using (for example) the Vanguard Emerging Market Index (VEIEX) mutual fund instead of the Vanguard MSCI Emerging Markets ETF (VWO). The Vanguard mutuals funds look good to me, but I thought I’d ask if you think he’s going along a good track. I don’t have a real clear response for him on why to use ETFs over mutual funds. I assume mutual funds can be a good investment strategy too.

Lazo

The Vanguard mutual funds are very good and he would not go far wrong with these funds.

Here are four minor differences between the Vanguard mutual funds and the Vanguard ETFs:

(1) ETFs cost around $8-$12 to trade depending on the custodian. Mutual funds can be between $25-$50 with some custodians or alternately they can be free to trade in some retirement plans. We use many of these funds in our retirement plans where there are no fees to trade them. Most 401(k) plans do not allow you to invest in ETFs, they require mutual funds. We avoid mutual funds in our taxable accounts and use the ETFs instead when there are higher fees to trade mutual funds.

(2) ETFs do not kick off capital gains until you decide to sell them. Mutual funds can kick off capital gains as the underlying index changes. This is small in a taxable account and does not matter in a retirement account.

(3) Sometimes the mutual fund has a minimum initial investment. For example, VEIEX, Vanguard Emerging Market Index (International) has a minimum investment of $3,000. With an ETF you could buy less than that, although we would recommend keeping the $8 trade low in comparison to the amount being purchased.

(4) The expense ratios can differ. We’ve found the ETFs to generally have lower expense ratios, e.g.:

VEIEX, Vanguard Emerging Market Index (International) currently has an expense ratio of 0.35%.

VWO Vanguard MSCI Emerging Markets ETF currently has an expense ratio of 0.22%.

Of course both of these have expense ratios much lower than the current emerging markets category average of 1.67%.

If you think your commission-based agent is bleeding your account with fees, get a fee-only fiduciary advisor to take a look at your portfolio. Visit NAPFA.org to find one in your area.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818…)