I've been looking into the benefits of owning a market index in an ETF vs an open-ended fund. Relevant facts:
- 5K lump sum investments - tax efficiency is important - dividends to be reinvested
I'm comparing the discount mutual fund companies to holding ETFs in discount brokerages. I used the Vanguard Total Index ETF (VTI) and Vanguard Total Market Index (VTSMX) to make my original comparison apples to apples. I'm assuming a long term holding of 10+ years and that the investor wants to track lots (specific share method) for tax purposes.
ETF + very low expense ratios (.07%) + most brokerage houses track lots (simplifying the accounting paperwork) + ETFs may be more tax efficient - some brokerage houses may charge for dividend reinvestment - brokerage houses charge per-trade, assuming a $20 fee for buy; disregarding time-cost, that's .04% per-year for 10yr holding - brokerage houses may charge to hold an account (maybe as much as $120/yr if holdings are less than a minimum) - there may be an ask-bid spread (.30% seems to be an average - buy+sell works out to $30 per $5K or .06% for a 10yr holding) - there may be a NAV to market price spread (I'm ignoring this)
Open Ended Mutual Fund + low expense ratios (.19%) + don't charge for share purchases (including dividend reinvestment) - only support average cost basis accounting
According to this simplified analysis, ETFs have a razor thin edge over mutual funds, to the tune of .17% vs .19% expense ratios. However, assuming sells in the same size lots at the buys, I'd also add a .04% sell commission to ETFs which would make traditional mutual funds win by .21% vs .19%. ETFs win in the ease-of-accounting space though, since the brokerage tracks the lots (assuming the shares stay at the same brokerage and the brokerage doesn't change policies). ETFs have an additional risk since brokerage houses may increase account fees or stop free DRIP programs.
Also, while ETFs can be more tax efficient it seems that isn't always true in practice. Is VTI actually more tax efficient than VTSMX? They are about the same according to the three year returns on Vanguard's site. It's possible that the VTI vs VTSMX difference is narrow here since VTI is essentially a share class of VTSMX. I'm not sure how the ETF is managed and perhaps spiders would be different here.
The net result is that for the apples to apples comparison open ended funds and ETFs are very, very close.
Did I miss anything important?