Vanguard expert discusses the costs associated with ETF investing

Vanguard’s Jim Rowley discusses the costs associated with ETF investing.

Notes:
All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
For more information about Vanguard funds or Vanguard ETFs, visit vanguard.com, or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, or other important information are contained in the prospectus; read and consider it carefully before investing.
Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
Advisory services are provided by Vanguard Advisers, Inc. (VAI), a registered investment advisor.
© 2015 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.  


TRANSCRIPT

Liz Tammaro: Another live question has come in. This one from Terrence asking, “So let’s say I have narrowed down my choice to one index class,” I think one asset class is what we’re saying here, “how do I determine and compare ETF transaction costs versus mutual fund transaction costs?”

Jim Rowley: I was going to say, one maybe the audience would find interesting and we had the question earlier about do ETFs have expense ratios? And the answer is yes. And when we think about transaction costs and expense ratios remembering the funds, an ETF or a mutual fund, it’s their expense ratio that they own, to use a certain phrase, but sometimes the transaction costs are not the funds necessarily. Brokerage commissions or some mutual funds might have sales charges if they’re purchased elsewhere. So if you buy a Vanguard ETF through Vanguard brokerage and you might not face a brokerage commission doing it there, but for some other investors who want to acquire a Vanguard ETF at somebody else’s investment platform, they might face the brokerage commission there. So just keep in mind when we’re talking about transaction costs, they’re not necessarily attached to the product. They’re part of that brokerage platform or investment provider’s transaction cost set up there. So they’re not always attached to the fund.

Liz Tammaro: Now I actually have another question that was presubmitted still on this topic of cost. I think it’s similar, but a little bit different. “So can you please discuss the relative cost over time of a fund versus an ETF?” I hear you talking about transaction cost and that seems like part of the initial cost, but how about this idea of cost over time?

Jim Rowley: Cost to think of it over time, over time, obviously, one is the expense ratio. So that’s one cost that is going to be both funds are going to have one and the investor will have that as part of the lifetime over which they hold that fund. I think some would consider taxes to be a cost so to the extent that a fund has any capital gains distributions. And at least for ETFs that are 40 Act funds, right, I referenced before the overwhelming majority of ETF assets they’re as 40 Act funds, they’re subject to the same rules under the Internal Revenue Code as mutual funds. So to investors, their taxation experience is the same. For example, if an investor who holds a 40 Act ETF when they buy and sell their shares to the extent they trigger any capital gains, if they buy and sell their shares of the ETF, they trigger capital gains and they would be subject to similar taxation. If there is portfolio activity within the ETF or within the mutual fund, and, again, when we’re talking about 40 Act funds, if there are any capital gains triggered by the portfolio, long term or short term, the investor is taxed at those appropriate long term or ordinary income rates. And then the third part being if the ETF, that’s a 40 Act fund or a mutual fund, if it pays any dividends, investors are taxed at that relevant rate the way they would be the mutual funds. So I use that as going back to the similarities, but, again, from the cost perspective, if expense ratio is one, taxes come up all the time as another one; and I think they’re worth heeding.

Liz Tammaro: Good. We’re getting so many great questions that are coming in. Now we have one that has come from Twitter. This person is asking or has tweeted, I should say, “I am not a day trader. Could ETFs be right for me?”

Jim Rowley: Yeah, I’d love to take that, actually, because I think on the green widget resource bar, there’s a blog that I had written about a conversation I had explaining ETFs to my dad.

Liz Tammaro: Sure.

Jim Rowley: And, you know, it was written off of a conversation I had with my dad; and he said, you know, he calls me Jimmy. Right, he says, “Oh, Jimmy, I’m not a day trader, so I don’t need ETFs.” And I said, “Well, you know, dad,” much like we’ve talked about here, “you can get ETFs that are broadly diversified index funds that come with low expense ratios. And just because you can day trade it doesn’t mean you have to day trade it. They are absolutely very well suitable as long-term strategic products in your portfolio.

Important information
All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
For more information about Vanguard funds or Vanguard ETFs, visit vanguard.com, or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, or other important information are contained in the prospectus; read and consider it carefully before investing.
Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
Advisory services are provided by Vanguard Advisers, Inc. (VAI), a registered investment advisor.
© 2015 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.