Learn how ETF prices are set and how the funds are taxed


Vanguard’s Jim Rowley explains how ETF prices are set and how the funds are taxed.

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: All right, so we are going to continue with the live questions. Dean is asking, “I’m still confused about the spread, the bid-ask concept. Which one do I pay when I purchase, which one do I sell at, and how does this create cost?” So let’s take a moment and just focus in on this bid-ask spread concept.

Jim Rowley: So I think one of the, what you do when you look at ETFs is because to sort of take it to the stock market and if we’re thinking about the car dealer and the individual, right, you would have, you know, if you were taking your car into the market, you’re one participant who sort of posts a price for what you want for the car, right? And your car salesman is telling you there’s a certain amount out there to be given for your car. So, I forget the numbers used. If your car was at $5,000, let’s say, that becomes the offer price out in the marketplace for that car. But if somebody’s only offering for him, his car, $4,900 or 800, that’s the bid price on the market. So you have a $5,000 offer out in the market and a $4,900 bid, right, that’s the ask price versus the bid price; and the $100 difference would be the spread that you would simplify the two.

Liz Tammaro: And a question from Ann, submitted to us from Colorado. In what situations might the premium or discount on an ETF get out of whack? Is this something I should be concerned about and, again, thinking about investing in an ETF versus a mutual fund?

Jim Rowley: One of the main causes that you might see a premium or discount is actually because of one of the features of ETFs. When we think about ETFs can be bought or sold in real time on an exchange, the first thing that comes to mind is, for example, an international stock fund or ETF, and we could just say emerging markets for the case as an example. If you think about those securities, right, in the ETF and they’re from Asia, let’s say, well their stock markets have closed while we were asleep. We haven’t even gotten up and started our day. So those stocks have been, those exchanges are closed. Those prices have been marked, so to speak, but the international stock ETF is trading here in the US. And it’s trading based upon news and information that’s going on right now. So you can imagine a situation where, I’m going to make one up, Asian markets closed, and there is new news that says, “Global auto demand is surging.” Well, as those Asian markets are closed, those US investors here are saying, “Wow, if those underlying markets were open, those stocks would be probably rising today.” And the opposed were true, right, if there was news that demand for computers fell, that would be bad news for the market. So what happens is the ETF is being priced by market participants who are saying, “What would those underlying securities be if those markets were still open?” So you could end up your day where there’s a premium or a discount because the news cycle, it’s closed in those overseas markets, but it’s running real time here and now.

Liz Tammaro: Good, thank you for clearing that up. I think that that’s helpful. One of our presubmitted questions is about taxes. We started to talk a little bit about taxation, Jim. We have Brenda who is asking, “Are there differences in the taxes paid on ETFs versus mutual funds?”

Jim Rowley: Yeah, happy to talk about this because there’s actually urban legends sometimes we hear. “Oh, ETFs, they don’t pay capital gains.”& I mean they can and they do. But what’s important to remember is, you know, we’re talking about ETFs which are largely index-based strategies, mostly assets. So indexing in and of itself is a very tax-efficient strategy. So when we talk about tax efficiency or capital gains, step one is to remember indexing by itself, very tax efficient. So when we see these benefits of, “Oh, ETFs are tax efficient,” remember, that kind of comes from indexing first and ETFs are weighted to carry that through. But maybe then to resummarize again is for those ETFs that are 40 Act funds, like we talked about, meaning they’re subject to the same regulatory environment as mutual funds, you know, whether or not you as the investor generate capital gains because you’re the one buying and selling the shares, right, number one. Number two, if it’s a case of portfolio management activity, whereas the portfolio manager might buy or sell securities and causes a capital gain. Or sort of number three, the portfolio, the fund generates a dividend and pays it out. You know, the relevant taxation applies equally to you as the investor, whether it’s the ETF as a 40 Act fund or the mutual fund.

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.