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In my last post, Opening the Books to Our Investment Portfolio, I broke down our entire portfolio. This included every holding and the values of each (rounded slightly just for security).
This turned out to be a pretty popular post and generated a little bit of fun discussion – both in the comments and through email several email conversations I had with readers.
One fair comment was about why I choose to buy the Vanguard ETF VTI instead of the Vanguard mutual fund VTSAX. These tend to be the most popular index fund versions in the personal finance community. And in my case, VTI is by far my biggest holding, accounting for over 67% of our portfolio… close to a million dollars.
But why VTI instead of VTSAX? In other words, why buy ETFs vs mutual funds?
I briefly answered the comment in that post, but I thought I’d take that a little more in-depth today.
Disclaimer: This should go without saying, but none of this should be taken as financial advice. I’m not a financial advisor, a CPA, or anything cool like that. I’m just some guy on the internet talking about what I do with our finances. I’ll do my thing and you do yours. Talk to a professional before making any changes to your own investments that you don’t fully understand.
First off, what the heck are ETFs and mutual funds?
Mutual Funds and Index Funds
Instead of owning a piece of a company through a share of stock, a mutual fund pools a bunch of securities together in one bundle. So a single share of stock might be for Amazon or Disney, but a single share of a mutual fund could have tiny pieces of hundreds or thousands of companies in it.
The big benefit to a mutual fund over owning shares of a single company is that you spread your risk quite a bit more. If a company goes under and you own individual shares of stock in that company, you can consider that money gone. But with a mutual fund, one company going under is likely just a small part of that fund and won’t make your share worthless.
Many mutual funds are actively managed by a “professional” money manager whose job is to get the right assets into that fund.
We’re not going to concentrate on that side of things though – we want to focus on the more passive type of mutual funds called index funds. These are funds that match a financial index such as the S&P 500 or the Dow Jones Industrial Average. Because there’s no need to pay overpriced money managers for their guesses on which stocks will be worthwhile, index funds are considered to be very passive. Along with that, they’re generally ridiculously less expensive to own than regular mutual funds.
Ok, so that’s a little information on mutual funds and, more importantly, index funds.
Exchange-Traded Funds (ETFs)
So if that’s the gist of a mutual fund, what the heck’s an ETF?
Guess what – an exchange-traded fund (ETF) is very similar to a mutual fund. An ETF pools together a bunch of assets (like stocks) just like a mutual fund does. And it can track an index just like an index fund does.
The big difference though is that a mutual fund price isn’t settled until the end of each trading day. You buy a share of an index mutual fund and you won’t know what exactly you paid for it until after the stock market closes that day. An ETF, however, trades like a stock and can be bought and sold at various prices throughout the day.
So aside from some structural differences that still pretty similar, right? So why does it matter?
So what’s the difference between VTSAX and VTI?
The reason we’re talking about these two securities is that they tend to be the most popular index funds in the personal finance community. As of my last post, Opening the Books to Our Investment Portfolio, VTI accounts for ⅔ of our portfolio with a value of about $989,000 (as of early December 2022).
The holdings between the two securities are identical. So whether you own VTSAX or VTI, you own the same holdings within each (currently 4,026 stocks as of 11/30/2022). They’re both cap-weighted, which means that the holdings they contain are proportional to their total market capitalization. In other words, each share will contain larger percentages of giant companies like Apple, Microsoft, Alphabet (Google), and Amazon over really small companies much lower down on the index.
In a nutshell, VTI and VTSAX are almost identical except that you’re dealing with ETFs vs mutual funds. There are a couple of slight differences between the two because of this.
The expense ratios are both extremely low but slightly different – as of this writing, VTSAX is at 0.04% and VTI at 0.03%. You also need a minimum investment of $3,000 to get started with VTSAX whereas you just need to be able to afford a single share price with VTI (currently floating at around $200).
On the flip side, you can buy fractional shares of VTSAX but you need to buy full shares of VTI. So if you have X amount of dollars, you can just purchase X amount of mutual fund shares even if it comes out to be something like 10.785 shares. With an ETF, you’d be stuck either buying 10 shares or 11. Sometimes that means being left sitting with not quite enough money in an account to buy an additional share.
Ok, hopefully, this gives you a better understanding of ETFs vs mutual funds and how similar they are with only a few slight differences.
Here’s why I prefer ETFs vs mutual funds
So, if the conversation about ETFs vs mutual funds leaves them to be so similar, why do I prefer ETFs and have the majority of our portfolio invested in VTI?
Yes, VTI is slightly more tax efficient than its counterpart, VTSAX. And that can be important as your holding becomes larger and could be affected depending on if you have it in a taxable brokerage account or a sheltered retirement account. We’re holding VTI in my taxable account, my rollover IRA (essentially a traditional IRA), and in three Roth IRA accounts.
So sure, a small difference in tax efficiency can make VTI a better choice than VTSAX… but that’s not the dealbreaker for me. The difference between the two is very slight so it’s not an end-all-be-all. If you’re interested in understanding that more, Dr. Jim Dahle from The White Coat Investor did all the hard work presenting the comparison in his post, VTI vs. VTSAX.
Instead, this ETFs vs mutual funds discussion really just boils down to this for me:
I like knowing the price I’m buying or selling at and the immediate liquidity that comes with it.
First off, as a long-term investor, the price I’m buying in at shouldn’t make too much of a difference. Timing the market shouldn’t be the game (though nothing wrong with buying low when an opportunity presents itself with other cash you’re just sitting on).
Even so, when I’m buying or selling something, I like to know exactly what the cost is. With an ETF, you buy and trade it like a stock so you pretty much know the price when you’re buying or selling. You can even put some guardrails in place in the process using order types such as limit orders to help ensure you don’t pay more than you want or sell for less than you expect.
With a mutual fund, however, you’re not going to know the buy/sell price until after the end of the trade business day.
Now, chances are, it’s not going to make that much of a difference. On a normal business day, the price shouldn’t fluctuate too dramatically… yes, on a normal business day. But, you never know – we’ve had plenty of crazy days in the market as well. So there’s a little bit of uncertainty there and that’s not something I’m comfortable with, especially when I have another easy choice… the VTI ETF.
Along those same lines, the second reason I prefer ETFs is the liquidity. If I want to sell, I want to sell immediately. I don’t want to have to wait until the market settles to know if I was able to sell my securities at a reasonable price.
I can’t foresee a day when I would want to sell some or even all of my investments at the drop of a hat… but just because I can’t perceive it happening doesn’t mean it won’t ever happen. We live in a crazy world and weird sh*t happens all the time (seemingly more and more as time goes on!).
If my Spidey Sense started tingling and the alarms were going off in my head about something really big, it might be good to have the ability to make a move before the hammer gets dropped. Set a limit price, sell, and it’s done… hopefully, within a short time before others get the same idea.
Needing to wait several hours for the end of the trading day giving time for others to decide to do something similar could be problematic. That could make the difference costing tens or even hundreds of thousands of dollars – if I could even sell at all.
Paranoid much? Maybe, but really I just like to try to at least be aware of scenarios that, while rare, could happen. And considering that with ETFs vs mutual funds the differences aren’t too big of a deal, this just adds another plus to the ETF column for me. Don’t judge me – someday folks might look back at this post and say that I was a genius in my thinking (I am, by the way!).
And that’s really it… knowing the price when I buy or sell, (hopefully) real-time liquidity, and the added bonus that ETFs are slightly more tax efficient than mutual funds. These are the minor reasons why with ETFs vs mutual funds, I’m going to go with ETFs with all other things equal (or close to it).
Should you invest in mutual funds or ETFs?
In my opinion, it doesn’t make that much of a difference overall and it’s going to come down to a matter of personal preference. I’m not against mutual funds and I’m not going to tell you that ETFs should be put up on a pedestal. They’re both worthwhile when used properly.
Maybe you like that with mutual funds you can buy fractional shares or do automatic investing (something I don’t believe you can set up at Vanguard with ETFs). That can make mutual funds a lot more attractive to you so you can set it and forget it. So maybe that’s the way to go for you.
There are a lot of small details that we tend to make too big of a deal analyzing such as:
- ETFs vs mutual funds (ie VTI or VTSAX)
- Index funds tracking the total stock market (ie VTI / VTSAX) versus just tracking the S&P 500 index (VOO / VFIAX)
- Investing in Target Retirement Funds or handling your own stock/bond mix and routinely rebalancing your portfolio (an absolute must if self-managing!)
These sorts of minutiae can no doubt make a difference in your portfolio, taxes, etc. over the long run. How much of a difference though is likely not going to be the defining factor on whether or not you’ll have a successful retirement. You also probably won’t know the better option until it’s in the rearview mirror and you have hindsight in your corner.
What is important is that you’re taking care of the broader details… and by that, I mean socking money away routinely. There’s no need to overthink this – no portfolio will ever be perfect. Start building a nice nest egg and continue to learn more along the way.
Again, I’m not a financial advisor, but my thought is that if your game plan is to go all-in with growth investing (as opposed to dividend investing), then stick with broad-based index funds at one of the three low-cost brokerages: Vanguard, Fidelity, or Schwab. Actively managed mutual funds will likely not perform as well as index funds over the long term and will probably crush you in fees and capital gains anyway.
You might also consider using a financial aggregate service to make it easy to track your investments and other assets/liabilities. I’ve used the free Empower (formerly Personal Capital) software for years and love it.
Other than that, most of these details are going to come down to being more of a preference. Some folks will recite to you a million studies as to why you should do things one way… and then someone else can do the same for telling you why you should do it the other way.
Work on just putting money away and don’t fret over the small stuff. Over time, if you learn just a little bit about some of these differences, you’ll find more confidence in deciding what makes more sense for your comfort level.
In the meantime, the small details like ETFs vs mutual funds aren’t going to make or break you.
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Plan well, take action, and live your best life!
Thanks for reading!!