Talli Sperry: Hi, I’m Talli Sperry, and you’re watching a replay of our recent webcast, Why all the talk about ETFs?—an in-depth discussion with our experts. We hope you enjoy it.
ETFs have been around for more than 25 years now, but they’re becoming more and more popular with investors. In fact, today more than $5 trillion is invested globally using ETFs*, and the number is still rising. It’s possible to build a diversified portfolio just by investing with ETFs.
Talli Sperry: While some of our viewers may be quite comfortable investing in ETFs, others may not know a lot about their unique benefits. In this evening’s webcast, we’ll learn more about ETFs. Our goal is to demystify and simplify ETFs and answer your questions.
We’d like to thank those of you who submitted questions in advance, and we encourage all of you to keep sending in questions as you’re watching. These conversations are designed to support and connect with the Vanguard community of investors, so we definitely want to hear from you. We’ll get to as many of your questions as we can.
Before we dive in, if you need to access technical help, it’s available by selecting the blue widget on your left. And if you’re interested in reading more about ETFs and Vanguard perspectives on investing, click the green Resource List widget, and that’s on the far right of the player. There you’ll find additional investing insights. With that said, let’s turn to our guests.
Talli Sperry: We have two really terrific and knowledgeable guests with us tonight. Joining me is Rich Powers. Rich is the head of ETF Product Management at Vanguard, and he’ll talk to us about what we should know about ETFs, new developments in the ETF marketplace, and Vanguard’s ETF lineup.
Also with us is Tim Holmes. He’s the head of Equities, ETFs, and Options Trading for individual investors. Tim will shed some light on how ETFs can help build your portfolio.
Welcome to both of you, and thank you so much for joining us tonight.
Rich Powers: Thanks, Talli.
Tim Holmes: Thank you for having us.
Talli Sperry: Rich, our viewers may not realize how popular of an indexing vehicle ETFs have become. Just in the U.S. alone, ETFs are showing at about $3.8 trillion*. Can you tell us a little bit about why ETFs have become so popular?
Rich Powers: Yes, I think a big story around why ETFs are popular now has a lot to do with investors paying more attention to costs, and costs are relatively low for index funds. Most ETFs happen to be index products, and so, naturally, if investors are focused on low cost, ETFs are a really great way to manifest that perspective in the investment vehicles you choose.
Talli Sperry: That’s great. I know recently Vanguard has won some ETF awards. We had three ETFs that won best in their class. Can you tell us a little bit about those?
Rich Powers: Sure. So ETF.com is an industry organization that looks at the quality of what’s happening in the marketplace. They have an annual award show, and Vanguard was recognized for three different categories.** One where we were called out for having the best new fixed income ETF. We were the first firm to launch a global bond market ETF in the ETF industry, which is remarkable given the importance of bonds in investor portfolios.
We were also called out for having a great new ESG ETF—”ESG” being environmental-, social-, and governance-related ETFs, a type of portfolio that screens out companies that may be involved in certain areas of the market that investors don’t want in their portfolio.
The last category we won is a newer category, which is the “best new active ETF,” and we have a quantitative-type strategy that was recognized in that area.
Talli Sperry: That’s great. That’s exciting stuff.
Thank you for explaining more about our award-winning ETFs, and you can actually read more about those in the Resource List widget. You’ll see an article about the awards that Rich just noted.
Tim, in your role managing trading for ETFs, have you seen any trends?
Tim Holmes: Yes, first of all, we’re seeing more and more clients use ETFs in their portfolio as a way to achieve long-term investment goals, much like they’ve been doing for years with mutual funds.
The other trend I’d highlight is that we’ve seen ETF costs over the years slowly decline, and I would put costs in a couple of categories. One would be the expense ratios of the ETFs. As they’ve gained scale, those costs have come down. But also bid-ask spreads, which we’ll talk about a little bit later, have narrowed, and that’s another cost. And then commissions: Many firms, including Vanguard, offer ETFs without a commission. And we now offer over 1,800 ETFs on our platform commission-free.***
Talli Sperry: That’s exciting. Good stuff.
Those of you who are webcast regulars will know that before we take questions from our viewers, we like to take the pulse of our audience by kicking things off with a poll question. Since we’re talking about ETFs tonight, we’d like to ask you about your experience with ETFs. On your screen now, you’ll see your poll question, which simply asks, “Do you own an ETF?” Your answers are “yes,” “no,” and “no, but I’m considering it.” And if you could take a moment to respond, we’ll come back to your answers in just a few minutes.
And while we’re waiting, Rich, can you kick us off with our first presubmitted question, which is: “What is an ETF and how does it work?”
Rich Powers: Yes, we jumped right in and used the acronym, but perhaps we unpack that first to make sure everyone’s on the same page. “ETF” stands for “exchange-traded fund,” so it’s a mutual fund that you buy or sell on an exchange versus going to an investment sponsor like Vanguard to purchase those securities.
In many ways, it’s very familiar to investors. It’s a mutual fund, and what that means is that it’s a pool of securities—either offering exposure to the stock market or the bond market. In many ways, it should be a very familiar structure to investors, even if the way they buy and sell is a little bit different.
Talli Sperry: Great, that’s very helpful. I think our poll responses are in, so we’re right on target.
When we look at whether our clients own an ETF, it looks like about 37% do own an ETF, 23% are saying no, and about 35% are saying no but they’re considering it. Is this split what you commonly see when you talk to clients and investors?
Rich Powers: You know, it’s surprising, actually. I think the number of investors in ETFs is a bit larger than what we’ve seen in terms of our own direct experience but also in some of the survey work that we’ve seen. It depends on the type of investor you’re talking about. Financial advisors tend to use ETFs pretty extensively. Individual investors who are building portfolios on their own tend to use ETFs a little bit less. So those are encouraging numbers, a little bit surprising.
Talli Sperry: Okay, so we’ve got a tightly tuned-in audience. That’s good.
We’ll take our second poll question now. Your question is, “Why would you hesitate to invest in an ETF?” Your first answer is “I don’t understand ETFs,” and that’s totally fair. That’s why we’re here tonight. The second one is “I don’t need to trade frequently.” And the third is “I don’t understand how to invest in an ETF.” If you could take a moment to respond, and we’ll get to your answers in just a few minutes.
Tim, I think I’m going to put you in the hot seat right now to talk about what the differences are between ETFs and mutual funds.
Tim Holmes: Sure.
Talli Sperry: Rich mentioned they’re familiar, but can you tell us the difference?
Tim Holmes: Yes, and I’ll build on what Rich highlighted. I think the main difference for an individual investor is really how you buy and sell an ETF. For one thing, mutual funds are transacted in dollars. ETFs, since they trade on an exchange like a stock, they are transacted in shares.
What that means is you have to convert the dollars to shares first. The other thing it means is you can get into an ETF by buying just one share, where most mutual funds have minimums of $1,000 or $3,000. That would be an advantage of an ETF.
The other advantage is that mutual funds are priced at the end of the day, whereas an ETF, the price is constantly changing throughout the day. So as an investor, you can see the price of your specific ETF anytime the market’s open.
Lastly, there are additional costs that are associated with ETFs in the form of transaction costs. Some could be a commission. In our case, we don’t charge a commission. For some, as we’ll get to later, there’s a bid-ask spread you may incur when you trade them.
Talli Sperry: Okay, that’s great. We’ve got our second poll in, and this is interesting. We’ve got a similar type of split. We’ve got about 47% of our audience that is saying they don’t understand ETFs, so it’s good that you’re with us here tonight. Then we’ve got about 31% that say they don’t need to trade frequently, so we can talk about that. And 21% say they don’t understand how to invest in an ETF. I think you are all in the right place this evening, so thank you for joining us.
Do keep submitting questions to us. We’ll take a live feed here, and we’ll actually break from our presubmitted questions to answer what’s on your mind. So feel free to chime in the discussion.
Thanks for that explanation. I think we’re going to move on to some of those presubmitted questions. I’ve got a question from Rick, which I’m going to ask you, Rich: “Are there any risks with an ETF that are more significant than with a mutual fund?”
Rich Powers: As I mentioned before, in many ways, funds and ETFs are one in the same. So any additional risks that you’d see in an ETF relative to a fund largely stems from the investment strategy of that ETF.
For example, if you’re buying a mutual fund and that mutual fund’s investing in short-term bonds, and then you buy an ETF that’s investing in international equities, there’s a different risk profile to the underlying securities. But in terms of looking at apples to apples, if you’re buying an international stock mutual fund and an international stock ETF, the risks are comparable. Again, the underlying strategy might reflect a different risk level.
There’s an additional level of responsibility an investor has in terms of how they enter their orders, be it because of how ETFs are transacted in the marketplace. So there’s just a little bit more effort that an investor has to take when buying and selling an ETF than maybe in the concept of buying or selling a mutual fund.
Talli Sperry: It seems like we need to focus on the underlying securities and the time in which we trade them. Is that fair?
Rich Powers: I think it’s fair.
Talli Sperry: Okay, great. We’ve got a live question, thank you. This one is from Donna who’s asking how we differentiate our ETF platform from those of our competitors. Tim, would this be one for you?
Tim Holmes: Certainly. I’d really highlight two things. First of all, as I mentioned earlier, all commissions are waived or there is no commission for trading ETFs at Vanguard, and that includes over 1,800 different ETFs. So that, I think, differentiates us.
The other is when we actually trade the ETFs, we try to get the best price possible. There are several ways we do that. One is we, obviously, look at the data in great detail, and we send orders to market centers that give us great execution quality, often minimizing or eliminating the bid-ask spread. We think that’s a key differentiator for Vanguard.
Rich Powers: I think another point to make here is that if you’re looking to buy a Vanguard ETF® and you’re considering whether you should buy it at Vanguard or some other brokerage platform, Vanguard is the only place where you’re guaranteed that all 80 of our ETFs will be commission-free. At other brokerage platforms, they may or may not be commission-free. There might be a charge you incur.
Talli Sperry: That’s a really key point. As long as we’re on the topic of price, I’m going to ask a question from Niles who’s from Virginia Beach. And he’s asking, “What does determine the price of an ETF?” Tim, maybe we can stick with you.
Tim Holmes: Sure, and I think we have a bid-ask spread chart. If we could bring that up now, I think that would be helpful.
So, like a stock, the price of an ETF is really determined by the supply and demand for that ETF. When you look at the bid-ask spread, what the bid represents is the most that someone is willing to pay to buy that ETF or stock. And the ask, or the offer, is the least that someone is willing to accept when selling. And the spread is the cost difference between those two.
That’s what determines the price in the market. But underlying that is really the value of the underlying securities that are in the portfolio. And that’s a little bit different than an individual security where, for example, Rich and I might both have an opinion on the price of Uber based on the prospects of Uber in the future. Whereas an ETF, there’s an actual value of the underlying securities at any given time, and that bid-ask spread is going to be right around that value.
Rich Powers: And you could tend to find, actually, with really heavily traded products or even products that are focused in really liquid segments of the market that the bid-ask spread tends to be really, really small. The more exotic the strategy, generally the more cost that comes from a bid and ask perspective.
Talli Sperry: That’s great. It’s good level setting for us as we think about just how we would actually use these vehicles.
I’m going to take a live question, and this is from Laura. Rich, I’m going to kick this one to you. She’s asking, “What’s the advantage of ETFs over stocks?”
Rich Powers: Yes, I think going back to a point around ETFs being a pool of securities, be it stocks or bonds, what you’re doing by buying a pooled vehicle that’s diversified across many, in some cases hundreds or thousands, of securities is you’re minimizing your risk that that one individual security you hold, be it a stock in your portfolio, goes down quite a bit—you’ve spread your bets across hundreds or thousands of securities. I think there’s that benefit in terms of risk.
You’re also benefiting from professional management, so you have portfolio managers who are—day in, day out—managing those assets on your behalf, trying to track a benchmark really, really well. And I think the last thing would just be cost. Right, at some point the efficiency of buying into an ETF or a mutual fund means you’re getting the benefit of the scale of that product when those portfolio managers are going out and transacting in the marketplace.
When you, as an individual, might be going out and buying those individual bonds or stocks, you’re not benefiting from that scale necessarily. And so you may be paying a higher price in terms of execution than you would by just simply buying a pooled vehicle.
Talli Sperry: Okay, great. Let’s stick with you for a second longer because, as a follow-up, we got this question, “Why not just buy a mutual fund?”
Rich Powers: Yes, that’s actually a reasonable question to ask when investors are thinking about whether an ETF works for them versus a mutual fund. If an investor has a lower amount of dollars to invest—as Tim was mentioning, many mutual funds have a $1,000 or $3,000 minimum—mutual funds might be prohibitive.
With an ETF, all you need to have in terms of making a purchase is the value of the NAV of that particular ETF. In some cases, that can be as little as $100 or $200 to buy a diversified portfolio share of an ETF. I think that’s a key benefit.
Some investors who prefer to trade with a little greater frequency, we want them using the ETF versus the mutual fund because if they’re very active in our mutual fund, they’re creating costs for everyone else. And so the ETF can be a vehicle for them. And, again, we’re not advocating for lots of trading. We actually see most of our investors build long-term diversified portfolios, but that could be another reason why an investor would consider an ETF over a fund.
Talli Sperry: Okay, great. That’s a good baseline for us to move forward with. Tim, I’m going to jump to you, “Are expense ratios typically lower for ETFs?” This is actually a presubmitted question from John.
Tim Holmes: I think Rich touched on this a little bit, but when you think of the mutual fund universe, there’s a large portion of that universe that is actively managed mutual funds. And so they’re paying people to have expertise to research the underlying stocks, and there are costs associated with that. Those funds typically are going to have higher expenses than an index fund.
The ETFs that are out now are mostly index products, so I think you could say, in general and on average, ETFs have lower expense ratios. But I think that’s really the main driver. That said, I think that the scale with ETFs growing has allowed them to start to lower expense ratios in ETFs. In fact, we have several ETFs at Vanguard where the expense ratio of the ETF is now lower than the counterpart mutual fund, and that’s mainly due to the scale and the growth of those products.
Talli Sperry: Okay, this is great. I’m going to move us through a bit of a lightning round of technical questions. We’ve got a couple presubmitted, and then we’re getting a couple coming in. I’ll start with you, Rich. Can you talk about the tax efficiency of mutual funds?
Rich Powers: Sure, so the tax efficiency of mutual funds relative to ETFs. I’d say, thinking about ETFs and why they’re often talked about as being maybe a little bit more tax-efficient than funds is that, to Tim’s point, they largely use index strategies. But why is that important?
Well, index strategies tend to have lower turnover. There’s less buying and selling because there isn’t a manager saying, “I like this stock. I don’t like this stock.” Rather they’re simply following a market-cap-weighted benchmark, and that invites less trading and, therefore, invites less capital gains incidents in that type of portfolio.
In addition, ETFs actually have this other mechanism that allows them to be a little bit more tax-efficient, and that’s this process of in-kind redemptions and in-kind creations. So if there are a lot of investors who want to redeem from our ETF, rather than having to sell the securities to meet that redemption, we hand those securities that we need to redeem to an institutional buyer who then sells them on behalf of those redeeming investors. That allows us to avoid generating capital gains because of the behavior or redemption activity of a population of investors.
Talli Sperry: Tim, would you add anything?
Tim Holmes: Yes, I think that’s a really important benefit of the ETF. In the end, the client really shouldn’t realize the capital gains until they end up selling the investment, hopefully years later, if it’s for a long-term portfolio.
Rich Powers: Yes, that’s a great point, actually. ETFs can allow you to defer the realization of capital gains until you actually decide “I want to redeem my position in this large-cap ETF,” versus having a distribution paid out to you at the end of the fiscal year because of different transaction activity in the portfolio.
Talli Sperry: And that strategy can be really important for managing a long-term portfolio.
Rich Powers: That’s correct.
Talli Sperry: Okay, great. We have a live question, “Do ETFs do dividend reinvestments?”
Tim Holmes: Most brokerage firms offer dividend reinvestment options for ETFs and other security stocks. And unlike a mutual fund, the way it works in an ETF is the ETF actually pays the dividend in cash, and then the brokerage firm, like Vanguard, will pool all those assets and go and buy shares of ETFs on behalf of all of those clients and then allocate them back to all those clients.
So yes, you can reinvest dividends. It just works a little bit differently than a mutual fund.
Talli Sperry: Okay, great. Just to reiterate a point, we have a question from David. He’s asking, “Are ETFs good to buy and forget for the long term?” I know we talked about potentially a long-term strategy, but can you speak to the “forget” piece?
Rich Powers: I think “forget” is maybe too strong of a word, right? We always want to revisit our asset allocation because our circumstances might have changed in terms of near-term needs or objectives. So “forget” is probably too far, but “buy and let alone for some period of time,” I think that’s a totally reasonable strategy.
In fact, you know, Tim’s team actually shared some data with a broader population of folks who care about ETFs here at Vanguard. I think last year the number was about half of our ETF investors—that is, people already owning ETFs—didn’t make a single trade in 2018. This idea that ETFs allow investors to trade frequently, theoretically that’s true. In practice, the data we have suggests that investors buy and build long-term portfolios, by and large.
Tim Holmes: Yes, and Rich, I would just add that what we see is clients adding to their portfolios by making an initial investment in an ETF and then adding additional shares as they have the means to do so. We see more buys in the ETFs than we do sells.
Talli Sperry: That’s helpful. Always focusing on that goals-based investing is our aim.
We have a question for you, Tim, which asks, “Can you explain a limit order?” If you could speak a little bit about how we trade ETFs and how we should get our mind around what to do when we’re actually using an ETF.
Tim Holmes: Sure. It might be helpful to bring that bid-ask spread chart up again. There are different order types that you can use to trade ETFs, buy or sell ETFs. Maybe I’ll start with the market order and get to the limit order that the client asked about.
A market order basically says “I want to buy or sell right now at the current price.” For most clients with a small number of shares, 100 or a couple hundred shares, on a normal day when we don’t have crazy volatility, that’s usually fine. What our goal is, when we get that order, is to try to get you the best price as possible. What we really want to do is try to get you the midpoint of the spread, basically eliminating the spread cost.
In 2018, we were able to do that about 95% of the time for clients trading up to 2,000 shares. So market orders are useful as well.
What a limit order does, and it can really be used in two ways: One is to set a price at which, when it gets to that price, “I want to trade,” whether it’s buy or sell. For a stock, I might say, “Hey, if Apple ever gets back to $150, I would love to buy it.” So I could put an order in at $150. You could do the same thing with an ETF.
The other thing you can do is place the limit order above the current price if you’re buying to protect yourself. Let’s say I’m buying an ETF and the markets are really volatile, and the current offer is $50 a share, which I’m willing to pay, but I’m worried it might spike up. I could put a limit in above that $50, let’s say $50.50. And basically what that says is “Buy this ETF for me, but if it gets up to $50.50, stop buying it.” And that really protects you from spikes. That type of limit order is called a marketable limit order, and what that means is the order should get executed right away, unless some volatility spike occurs while I’m placing my order.
Talli Sperry: Great, so we can control how much we spend in those moments.
Tim Holmes: Yes.
Talli Sperry: Rich, I’m going to go back to a clarification of something you said earlier. We’ve got Gerald asking, “Can Rich clarify why investors do not get the NAV of the ETF as with a mutual fund if the risks are both identical?”
Rich Powers: Yes, with a mutual fund, an investor is sending in their $3,000 to buy that fund. At the close of business at 4 p.m., Eastern time, we’re striking an NAV, and whatever that $3,000 buys, you get that many shares.
With an ETF, because it’s a security that trades on an exchange, the ability to transact in that ETF only happens at the time in which the exchange is open, so 9:30 a.m. to 4 p.m. At 4 p.m., the NAV isn’t necessarily struck for the ETF, and so your ability to transact with NAV is not available for an ETF. It could theoretically happen, but it’s not the experience that 99.9% of investors have.
Anything you would add there, Tim?
Tim Holmes: Yes, I would say that if you are an institutional client trading hundreds of millions of dollars of ETFs, you may try to do a trade at the NAV, but because of the reasons you said, most clients are going to be trading during the trading day and during the current price of the ETF at that time.
Talli Sperry: Great. As we talk about trading, I think some investors may find themselves asking, “Am I set up to do trading? Am I set up to do active trading? Does this get into active trading?” Let’s try to do some clarification about who ETFs are good for.
Let’s take this question from Mel. It’s a presubmitted question. Thank you, Mel. He’d like to open a Roth IRA for their 12-year-old son who’s now starting to dog sit and mow lawns for under $500 a year. Super cool first job. And he can’t open a target-date fund with Vanguard yet, so he’s wondering if an ETF might be the best option. Rich?
Rich Powers: Yes, I’ll get right to the point I made earlier that the entry point into an ETF is actually the market price of that security. In the case of, say, our Total Stock Market ETF, which has an NAV of around $200, Mel’s son could purchase that product for $200 a share and have broad diversification in U.S. equities in one fell swoop.
That’s a value for investors who maybe don’t have the minimums to meet as they’re building their portfolio. The entryway into ETFs is a bit lower than what they find in mutual funds.
Talli Sperry: So they can be good for an investor of any age.
Rich Powers: Right, absolutely. If we look at the population of investors who end up buying ETFs at Vanguard, it actually runs the gamut. It runs from your youngest investors to those investors who’ve been in the market for 50 years.
Now, that said, we do see younger investors—say 20s, 30s, 40s—tending to use ETFs a little bit more than other age cohorts, but the adoption is pretty pervasive across all age groups.
Tim Holmes: Yes, and I would just say for those small incremental investments, not paying a commission is really important because the commission, if there were a commission, could eat up a good bit of that initial investment. It allows you to, once a month or every other month, buy one or two shares of an ETF.
Talli Sperry: That’s such a great point and such a Vanguard advantage there too.
Let’s go to a follow-up question. This is from Mary Rose in Hastings-on-Hudson, New York. And she’s asking, “For a young person who’s looking to invest, would you recommend ETFs as a good option?” And just to clarify, it sounds like you will, but are there certain ETFs they should think about more than others?
Rich Powers: Yes, I think for an investor who’s just getting started, that doesn’t have a large pool of assets to diversify across a number of different portfolios, those types of investors probably want to start with broadly diversified products for themselves.
So thinking about total market type portfolios where you’re getting that diversification I talked about before, where you’re not taking a lot of individual security risk, where you’re spreading your bets across sizes of companies, sectors of companies, maybe even geographies that companies are operating in. Those are the types of products where investors just getting started and not having a large pool of assets to invest across multiple products probably want to start.
Talli Sperry: Very helpful. Let’s jump back to some of our live questions. You guys are bringing them in, which is so much fun.
This is from Bill. He’s concerned about the liquidity of ETFs. He’s asking, “What’s the size of the daily market for ETFs?” Tim?
Tim Holmes: We do get a lot of questions about the liquidity of an ETF, and it’s a little bit different than an individual stock.
First of all, you want to look at how many shares trade in a given day in that ETF. That’s an indication of how many buyers and sellers are interested in that ETF, and the more volume there is, the tighter that bid-ask spread is, so the less the transaction cost.
The other equally important aspect of liquidity for an ETF is the liquidity of the underlying securities that make up that particular ETF. If those are highly liquid, even if there aren’t a ton of shares trading for that ETF, the ETF’s very easy to create. So a market participant, a market-maker could go out and buy the underlying securities and pretty easily create more liquidity of the ETF.
Tim Holmes: The other thing that I would highlight is that it’s really relative to your order, so you want to be cognizant of the size of your order versus the daily trading of an ETF. And, particularly, if your orders start to get rather large, that might be when you’d want to call someone like Vanguard. And we would help you with how to place a trade in a way that’s appropriate given the size of your order.
If you’re placing an order for a 1,000 shares and that ETF only trades 9,000 shares a day, you’d probably be best-served calling Vanguard or a block desk or a high-touch desk that would look at the liquidity at a little deeper level and help you decide what type of order to place to get the best price possible.
Talli Sperry: Great. I’m going to jump to our question from a Facebook viewer. Thank you so much. And he’s asking, “May I purchase an ETF out of my brokerage account? In other words, exchange Vanguard 500 for a specific ETF?” Tim, another brokerage question.
Tim Holmes: If I understand the question, they have the 500 Index Fund.
Talli Sperry: Seems like it.
Tim Holmes: Yes. At Vanguard, and this is unique at Vanguard, we do have the ability to convert your mutual fund into an ETF, and it’s a tax-free transaction. Basically, what we do is we take the closing value of the NAV of both products, and it’s almost like an exchange where you end up with shares in the ETF equivalent to the value of that NAV at the close.
Talli Sperry: That’s a great advantage.
Rich Powers: But you do need a brokerage account to do that, right? That’s very important. Many clients have that, not all clients do, so the presence of a brokerage account is really important. It allows you to consider whether ETFs are good for you.
Talli Sperry: That’s a really great point.
To clarify, we’ve done some pricing changes recently, and I think that’s where this question from Jack is coming from. He’s asking, “Are ETFs better than Admiral™ Shares of a mutual fund?” Rich, could you speak to that?
Rich Powers: I wouldn’t say one’s better than the other. Actually, they serve different populations of investors really well. For certain investors, let’s get back to Tim’s point earlier, there are about 20 of our ETFs that have announced that they have lower prices, and some of those have lower prices than the Admiral Shares, one to two basis points difference in the expense ratios.
That may be attractive for some investors who say, “I want a lower-cost option. I’m going to use the ETF.” But as we talked about before, there are other dimensions to buying and selling ETFs that someone needs to be willing to embrace to consider them.
For example, actually having to enter an order and what type of order do you use? There’s the bid-ask spread that comes with transacting in ETFs. There are things like automatic investment plans that people really value in the mutual fund space that aren’t available in ETFs because they’re marketable securities. So on a cost basis, maybe the ETF has some advantages.
But you have to look at your particular circumstance and do you place value on features like automatic investment, and are you comfortable with the trading aspect? If you are, then maybe the ETF is the right answer. But it’s not as simple as one or the other.
Talli Sperry: That’s great. As a follow-up on the question about the types of situations that might be better for ETFs or not, this is Lakshmi. He’s investing for the long term, approximately 30 years, and doesn’t trade regularly. Is an ETF still a good choice?
Rich Powers: A fund or an ETF actually works in either one of those circumstances. The utility of trading doesn’t appear to have much value to Lakshmi. That’s great. If he’s starting at a low asset level, maybe the ETF is the entry point, which gives him access to investing versus, say, a mutual fund. And if he’s willing to take on a little bit more responsibility in terms of trading, the ETF could be the right option.
But either one is going to be a great option for investors. It’s just where you place your value in terms of preferences around utility features of the fund versus the ETF.
Tim Holmes: Yes, and I would just add, you mentioned right now that we do have some ETFs that are a basis point or two cheaper than the Admiral Shares. If that were to get wider, and everything else being equal, then the ETF would be the choice for the long term, given that we want to keep expenses low.
But at one or two basis points, I think it’s really more of a toss-up in your preferences of how you want to buy and sell the product. There are certain benefits of being in a mutual fund. There are certain benefits of being in the ETF.
Talli Sperry: We have a question from a savvy investor. Donna is asking, “Please discuss your fee structure. If your ETF offerings are commission-free, how do you earn money?”
Rich Powers: The reason why we’re able to bring a commission-free offer to the marketplace is because Vanguard’s enjoyed just incredible success as an organization in terms of scale and growth.
Our organization is set up as such that the folks that we work for are actually our investors. There are no public shareholders; there’s no private family that we’re working for.
As we gain that scale, we’re able to return that value to shareholders in the form of lower costs, be it expense ratio, be it the commission-free offer, be it enhanced services and content and things like this that we offer to our clients.
That’s how Vanguard’s able to eliminate commissions for investors who want to consider ETFs. We just made the decision-making process for investors—when deciding around ETFs—a lot easier. Instead of having to look at the expense ratio, the tracking of the portfolio, the exposure offered, the tax efficiency, and then the commission, we’ve taken one of those considerations off the table.
That’s really one of the key areas we’re focusing on, which is improving investor experiences and outcomes. And we’ve removed that by eliminating commissions.
Talli Sperry: That’s great. That’s a huge advantage to all of our investors.
Let’s jump through a bunch of our live questions. And this one is from Rita who’s asking, “Are ETFs available for Roth IRAs?”
Tim Holmes: Yes, ETFs are pretty much available in any type of account, as long as it’s set up in a brokerage account. We can open up Roth IRA brokerage accounts where you could buy an ETF. The Roth is really just the tax treatment and the instrument in which the account lives, and the products within the Roth can be ETFs or mutual funds.
Talli Sperry: Ryan is asking, “When I own an ETF, how am I charged the expense ratio?” How does the charge come back to the investor?
Rich Powers: In a mutual fund or an ETF, the expense ratio works the same way—the return that’s available to that product is reduced by the expense ratio of the product.
For example, if the return of the underlying securities of that portfolio was 10% for a given year and the expense ratio for that product was 0.10%, so ten basis points, the actual return that the investor would realize and experience would be 9.90%. The 0.10%, which slowly reduces the net asset value over the course of the year, reflects that ten basis points.
Talli Sperry: Sayid is asking, “Are we allowed to convert from an index fund to an ETF without incurring income tax?” I know we talked a little bit about the conversion a few minutes ago, but maybe you can elaborate on the tax piece.
Tim Holmes: Yes, at Vanguard—I guess it’s due to our unique share class structure—you can move from a Vanguard mutual fund, assuming there is an ETF for the same fund. You would call us, and we would talk through some tax things that you might need to consider, like your cost basis treatment and whether you want to carry that over to the ETF or not.
But as far as the actual transaction being taxable, it’s not taxable. You end up going one day from the mutual fund, and the next day you have the same product but it’s in the ETF wrapper.
Talli Sperry: Okay, great. Rich, I’m going to ask you a clarification question. Vera says, “We keep talking about ETF mutual funds. Is this a true mutual fund or is it an index fund?” Can you go back to our definition of ETFs and help clarify?
Rich Powers: Sure. Mutual funds and exchange-traded funds, ETFs, most are governed by the same regulatory framework, which is the 1940 Act—meaning that they have the same four responsibilities, the same regulatory and operational considerations.
There are ETFs that follow an index strategy, actually most ETFs follow an index strategy, meaning they’re following some benchmark, like the S&P 500. There are some ETFs that follow an active strategy, but they tend to be in the minority in terms of the products.
In the mutual fund space, where you’re buying and selling at the 4 p.m. close, most mutual funds are in active strategies. And let’s say 20% to 30% of all mutual funds are in index strategies, similar to what we see in ETFs.
The difference between the index mutual funds and the index ETFs is how you interact with them. You need a brokerage account to buy the ETF, and you can purchase that throughout the day. In contrast to the mutual fund, you don’t need a brokerage account, and you can only buy or sell that at 4 p.m.
Talli Sperry: Tim, would you add anything?
Tim Holmes: No, I think Rich hit on it that the actual underlying investment is the same in those two scenarios. It’s just the wrapper. In one case it’s the mutual fund structure, which is priced once a day. That same portfolio can exist in an ETF structure where it trades throughout the day and allows you to use different order types and keep track of it throughout the day.
Rich Powers: Think of it in a car context, right? There are different types of SUVs that you have out there on the marketplace. Some have certain features that I might find really attractive and necessary as I’m driving. You, on the other hand, Talli, if you’re looking for an SUV, you might value certain other features.
Think of mutual funds and ETFs as being built off the same chassis but offering different features that could be valuable to one investor versus another.
Talli Sperry: That’s a great analogy. And I’ll just direct our audience back to your Resource List widget. We actually have a notation in there of ETFs versus mutual funds, and I find that a really helpful piece to continue to reground myself in these concepts as we’re learning.
To our last slide of questions—so feel free to send some more right in. This one is asking, “For an ETF, which is the better way to hold it, long term or short term?”
Tim Holmes: Similar to a mutual fund, we would say build a portfolio for the long term that’s appropriate for your risk tolerance and your objectives, and then check in and rebalance it regularly. Also, if your situation changes, maybe your goals change or your risk tolerance changes, then you would adjust the portfolio. I think it would be very similar to how you would invest in a mutual fund.
Rich Powers: And as you’d expect from Vanguard, we’re always espousing the long-term view. We find that professional and nonprofessional investors have a really challenging time identifying the right time to buy and sell a fund or an ETF.
Building a portfolio that meets longer-term objectives—and to Tim’s point, rebalancing, making sure that’s still aligned with where you are from a risk tolerance and goals perspective—is the right approach. Short-term trading usually ends in, well, suboptimal outcomes.
Tim Holmes: Yes.
Talli Sperry: Not exactly where we want to be. Goal-based investing is what we’re focused on.
Let’s go to our presubmitted questions, and we’ve got Fibrizio from Laguna Niguel in California—we were just there for a client event. He’s asking, “How can I minimize the selection of four to five ETFs?”
Rich Powers: It’s an interesting question because there are about 2,000 ETFs in the U.S., and that creates some challenges for investors, like “where do I start to whittle my portfolio down to a handful of portfolios?”
Vanguard thinks about this quite a bit because helping investors make good decisions requires guiding them toward products that are going to serve them well. We only have 80 ETFs; there are 2,000 in the industry. So that tells you there’s a lot happening outside the walls of Vanguard.
We have a list of 80 ETFs in our platform. An investor who wants to be very hands-on and build a portfolio one by one can select from that 80. But then recently we just rolled out a select list of ETFs. These are 13 ETFs that represent broad market exposure, be it to stocks or bonds. And an investor could assemble, relatively easily, four to five ETFs in one portfolio that gives them global diversification across the U.S. stock market, international market, the U.S. fixed income market, the global fixed income market.
We’re thinking a lot about how we can make the decision-making process simpler, but we know that we have a range of investors—some like to be very hands-on, others want a little bit more guidance—and I think that list of select ETFs is a good place to start for that latter group.
Talli Sperry: We really can build a diversified portfolio with just ETFs now. That’s exciting.
Rich Powers: Yes, and extremely low-cost too, as Tim had alluded to earlier. The price and expense ratio for ETFs continues to fall, so you can build a global diversified portfolio pretty close to around ten basis points.
Talli Sperry: That’s awesome. Tim, one of our presubmitted questions talks about how we ensure we get a fair price with an ETF. Can you speak a little bit to that?
Tim Holmes: Sure, and I’ll touch on some of the things I mentioned earlier about order types. Again, when buying or selling an ETF, be cognizant of the size of your order relative to the ETF that you’re trading. And in most cases, using a market order, you’re going to get a really good price. We strive to get midpoint. We try to eliminate that bid-ask spread and have been really successful at doing that.
As the order gets larger, that’s when you’d want to consider using a limit order, or as I mentioned, a marketable limit order just to protect yourself and make sure that, if there’s a certain amount of money you want to spend, you set a price so that you don’t spend more than that. But, typically, a market order, normal trading day, you really get a great execution.
Talli Sperry: Okay. As we think about long-term portfolio construction, we’re getting a live question from Mira who’s asking, “Is it better to have a portfolio of just ETFs or a mix of products?”
Rich Powers: We actually see a range of construction. We have investors who just use mutual funds. We have investors who just use ETFs. And we have investors who use a combination of both.
We see that not only from individual investors who are building their portfolios, but actually professional investors, advisors, who are thinking about the best way to maximize their risk/return profile and the cost components of their portfolio. It might involve using ETFs and funds together. Funds “or” ETFs? It actually can be “and.”
Tim Holmes: Yes, and I think it’s really the underlying ETFs or mutual funds that you’re using to build the portfolio that are important. You’re not necessarily diversifying away from ETFs by buying mutual funds. It’s more around the individual fund or ETF that you’re using to build the whole portfolio.
Rich Powers: Yes, a lot of times you’ll see that there are notes in the press that ETFs are beating funds or they’re better than funds. They actually work together really well because, as we talked about before, they’re very similar. It’s just they might offer different features that some investors value versus others.
Talli Sperry: Also, I find as I work with clients that investors have different goals for different portions of their portfolio. I think there could be an advantage to having both too.
Tim, you talked about ETFs being traded throughout the day. How can that be done when multiple equities are contained in one fund?
Tim Holmes: Sure. As we mentioned before, the price of the ETF is really driven first by the supply and demand and the buyers and sellers that are buying and selling that ETF. But underlying that is the securities that make up the ETF, and those are trading throughout the day. And that actually helps price the ETF because at any given time a market-maker who is facilitating buys and sells has a sense of what the value of that ETF is, based on the underlying holdings. If it’s our S&P 500 ETF (VOO), the prices of those 500 securities are known throughout the trading day and that will drive the value of that ETF.
Talli Sperry: Great. Another live question, and this one is from Sarah who is asking, “How many different ETFs could you invest in?” And I think you guys have a great chart of the universe of ETFs.
Rich Powers: Yes. We alluded to this before, but there are 2,000 ETFs in the marketplace. There’s been a large number of ETFs launched over the last decade or so.
We take our time in terms of product development, so we haven’t had an instance where we’ve closed any of our 80 ETFs that we launched over our 18 years of being in the ETF business. But you could begin with 2,000 as kind of a starting point.
As I mentioned, Vanguard’s got 80 ETFs. No reason to build a portfolio with 2,000 ETFs or 80 ETFs in it. You can get down to a globally diversified portfolio in a matter of five or so ETFs. If you said, “I want a globally diversified fixed income portfolio, a globally diversified equity portfolio,” I would do that in as few products as possible. We have two different products you could pair together, and then you’d have the world covered in simply two products.
Talli Sperry: That’s incredible.
Tim Holmes: Yes, more is not necessarily better when building a portfolio. It’s really the diversification and the portfolio that you’re building. And as Rich mentioned, you can do that with a handful of ETFs or mutual funds. It’s very similar.
Talli Sperry: Great. This is a live question from Zack who’s asking, “If I have a 25- to 30-year window for investing, how much should I be concerned with the bid-ask spread—i.e., time in the market versus timing the market?” Tim?
Tim Holmes: For a long-term investor, I think it’s de minimis. First of all, if you’re incrementally buying in, we’re likely going to eliminate most of that bid-ask spread for you. And then over the long term, really the outcome of that investment is going to be driven by the underlying portfolio of securities, particularly over a 25- or 30-year period.
Talli Sperry: Great. We know ETFs are traded throughout the day, and we’re getting a question from our presubmitted list. And this one is, “Are there limits to how many times we can trade ETFs?” Tim, maybe we’ll stick with you there.
Tim Holmes: There really aren’t any limits. I think what we see is clients buying and holding them, so we don’t really see clients actively trading ETFs like you might. Actually, we don’t see a lot of clients actively trading equities here at Vanguard like you might at some of our competitor firms. So, yes, I think most clients will buy an ETF and then add to it periodically or maybe sell it if they’re adjusting their portfolios. There is no limit to how many trades you can do with an ETF.
Rich Powers: But, as we talked about before, trading a lot is usually not in your best interest. The ability to time the market and move from one area to the other—we’ve seen it time and time again—it simply doesn’t work.
Tim Holmes: Yes, and I will add our brokerage platform is really not built to cater to someone that wants to be extremely active. It’s more for the Vanguard buy-and-hold, long-term investor.
Talli Sperry: Yes, we maintain our long-term focus across all our products, right?
I’m going to take two questions and combine them. Rich, I’m going to kick these to you. One is a presubmitted question asking, “Does Vanguard have any plans to offer active ETFs?” If you could elaborate on that as well as William’s question, “Are there any Vanguard ETFs® that have a unique or different asset mix from existing Vanguard mutual funds?”
Rich Powers: Sure, I’ll start with the active fund. We actually have six active ETFs. We launched them February of 2018. They’re called factor funds. These are funds that focus on different investment strategies that are known to have some empirical evidence of offering either potentially greater returns or minimizing risk. They’re quantitatively driven. Of course, they’re low-cost because they’re from Vanguard.
We have a suite of six active funds in our lineup. I mentioned before in the industry there are not many active funds, though there’s kind of a groundswell of interest by many firms to bring active strategies to ETFs.
One of the impediments to active ETFs becoming more prominent in the marketplace is that the ETF provider has to reveal the holdings usually on a daily basis.
For an active strategy, that can be problematic because perhaps the secret sauce that comes with delivering that active strategy is now in the marketplace and available for everyone to see. Many managers have loathed doing that, or when they’ve been comfortable doing it, it’s only for very specific strategies.
I think active is a place that we don’t have a large population of options today, but it’s a place where we actually are doing some thinking. We have a long approach to product development where we think about what the investment case is for a product. What’s the demand for it from investors? Can we do it well and can we do it inexpensively?
If an active ETF strategy can make its way through that filtering process, then we might have more products in that category. But it’s certainly a topic of great interest among lots of different investors.
Talli Sperry: That’s exciting. And then can you speak to William’s question about the different or unique asset mixes compared to Vanguard mutual funds when you think about ETFs?
Rich Powers: Yes, I think because many of our ETFs are share classes of our existing index mutual funds, these strategies that are available in the funds and ETFs are identical. There are a handful of strategies that are only available in the ETF.
I mentioned before the global bond ETF as an example of that. Also, we launched a series of ESG products last year that are only available in the ETF wrapper. And then I think the last ones that come to mind are those active strategies that I called out earlier. They’re only available in an ETF structure. They’re not available on the mutual fund side.
Talli Sperry: Great. And for clarification for our audience, can you again define “ESG” for us?
Rich Powers: Sure, “environmental, social, and governance.” These are strategies where investors want to minimize or avoid exposure to certain categories of stocks.
Great examples of that, which are actually reflected in our portfolios, are those products that omit companies involved in tobacco, firearms, power. As an example, companies that are removed from the portfolios in the international and U.S. space and the resulting portfolio is a product that’s more aligned to ESG perspectives.
Talli Sperry: I think our audience wants us to cover the tax effect again. Owen is asking, “Suppose I buy an ETF and never sell. Is there an annual distribution I have to pay tax for?”
Rich Powers: It depends on the ETF strategy you’re talking about. If you’re in a regular investment account and you buy the Total Bond Market ETF, for example, you’re going to receive dividends every month. At the end of the year, you’re going to get a 1099 that’s going to tell you that you owe taxes on the dividends you received.
Now if you held that Total Bond Market ETF in an IRA, there aren’t any taxes on that because IRA investments are tax-deferred investments. Your tax incidence depends on the strategy. Bond ETFs can throw off a lot of income. If you’re holding that in a taxable account, you’re going to have a taxable event there. If you’re holding that in a retirement account, not relevant conversation.
Talli Sperry: Great. Rich, one last point of clarification, and then we’ll kick some questions to Tim here. Someone is asking, “What are the two ETFs that you were referring to when you noted an investor could purchase to get global diversification with a minimum of products?”
Rich Powers: Sure. The equity portfolio is Vanguard Total World Stock ETF. The ticker symbol is VT. And then the fixed income portfolio is Vanguard Total World Bond ETF, and the ticker symbol is BNDW.
Talli Sperry: Tim, I’m going to send this question to you. Why do some commentators say ETFs are an extreme risk in a hard downturn?
Tim Holmes: Yes, I’ve heard those same comments. I think the first thing that I’d say is, as we talked about earlier, ETFs have been around for over 25 years. And during those 25 years, we certainly had some turbulent markets. In that period are the tech bubble and the financial crisis. At first I’d say I think they have stood the test of time. To see the assets where they are today, I think is evidence of that.
I think the main risk associated with ETFs is really the underlying securities and the strategy being deployed in that ETF. As Rich mentioned earlier, a short-term bond ETF is going to have much less of a risk profile than an international equity ETF. And those are the things that really drive the risk within that ETF.
Talli Sperry: Okay, as we move toward our final thoughts, I think we’ve had a lot of questions with our clients asking whether to go for an ETF or a mutual fund. And you guys certainly kept us busy tonight, which was really wonderful to engage in dialogue with you.
As you think about your closing thoughts, maybe you could just speak to how there’s not a simple answer but the factors that we need to consider when thinking through this decision. Rich, I’ll start with you.
Rich Powers: Sure. We talked a little bit about how most ETFs are index-based. If you’re an investor who prefers active investing, an ETF might be able to satisfy that need. But the population of ETFs that are focused on active are smaller. That might change over time. But if you’re oriented toward active, then it’s probably going to guide you toward considering mutual funds.
I think also the things to consider when looking at the ETF versus mutual fund decision-making is how much money you’re bringing to the table. Are you able to meet the minimum for the mutual fund? If you’re not, that might guide you toward the ETF. Also, consider whether you value the liquidity provided intraday of an ETF versus 4 p.m. pricing for a mutual fund.
And then lastly, as Tim was alluding to, some of our ETFs are lower-cost from an expense ratio standpoint than the comparable mutual fund. If you’re a long-term investor, in that you’re not going to be very active with that and those differences grow over time, then the ETF is going to provide you a lower-cost experience than the comparable mutual fund.
Talli Sperry: Very helpful.
Tim Holmes: Yes, and I would just add that, as we discussed, the ETF has to be traded in a brokerage account, which can seem a little bit more complex.
Hopefully, we’ve demystified some of that this evening, but I would encourage investors to go to our website and look at the resources there. And certainly call us if you’re interested in buying an ETF and you’re not quite sure what order type to use, or you have questions about how to place the order. We’re here to help and can walk you through that and educate you on the process.
Talli Sperry: It sounds like we should think about setting up our brokerage account and checking out the resources in our widget to talk about trading.
Thank you both for joining us here tonight. This was a really great and very insightful discussion.
Tim Holmes: Thank you.
Talli Sperry: And thank you, members of the Vanguard community, and those who may be new to our webcasts, for joining us tonight.
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On behalf of Rich and Tim and all of us here at Vanguard, thank you and good night.
*As of April of 2019, more than $5 trillion is invested globally in ETFs (nasdaq.com), and $3.8 trillion is invested in ETFs in the United States, (Investopedia.com).
**ETF.com Award winners are selected in a three-part process designed to leverage the insights and opinions of leaders throughout the ETF industry. The awards process began with an open nomination period running from December 3, 2018, through January 3, 2019. Following the open nominations, the ETF.com Awards Nominating Committee—made up of senior leaders at ETF.com, Inside ETFs, and FactSet—voted to select up to five finalists in each category. Winners from these finalists were selected by a majority vote of the ETF.com Awards Selection Committee, a group of independent ETF experts. Committee members recused themselves from voting in any category in which they or their firms appeared as finalists. Ties were decided where possible with head-to-head runoff votes.
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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.
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