DISQUS

thomas · 10 months ago

Thanks. I've been wanting read more about the advantages and disadvantages with ETFs and index funds. I see advantages to both and with each of them you have to make sure you look at total cost. $8 a trade for ETFs might seem like a lot, but if you are giving up 1% for a non-index fund you could be losing much much more!

Green Panda · 10 months ago

Thanks for going into detail about the fees and charges between index funds and ETFs. I went to an investing workshop months ago at my old job and the guys didn't even explain this.

Rassah · 10 months ago

Sadly, most good index funds cough vanguard cough require an initial investment of $3,000. I'm just starting out, so I have to rely on buying ETFs (about $200-$250 a month). Once that gets to $3,000, I roll it into an index fund. Also, once you hit over $100,000, you get to a point where you would actually break even or save money if you maintain your own portfolio to match index funds (takes about 20 to 30 different stocks to completely diversify away risk, from what I remember). So, my personal path is ETFs to start, index funds in the middle, and my own stocks when I break $100k to $120k.

rocketc · 10 months ago

I would love to get more involved in investing . . . but I have no capital. Probably the best way for someone like me to jump start a nest egg is to max out what your employer matches in your employer retirement plan. Even in a down market you double your money right away.

Mrs. Micah · 10 months ago

I tend toward indexing simply because I'm looking at the long term. In fact, I don't think I'd ever buy stock when I was looking at a time-frame under 5 years (or longer). And it seems to me that the only advantage of ETFs is their tradability.

I'd thought, though, that one could automate investing in ETFs?

Dave_N · 10 months ago

Hi,

Aren't we missing a relatively big tax advantage of ETFs? I had thought, and I could be wrong, that ETFs do not have to capital gain distributions. Am I wrong about this?

Thanks.

Dave N

Mike · 10 months ago

Rassah - that's a good point about Vanguard's $3k minimum which I conveniently glossed over.

Bottom line with low cost investing is that you have to know what the costs are, whether you buy etfs or index funds or both. The reality is that most investors have no idea what their costs are.

Dave - ETFs most certainly do have capital gain distributions. If the underlying stocks pay a dividend (of any type) then the ETF does as well.

kitty · 10 months ago

Dave N., you are right. I am surprised nobody else caught on. With ETFs just like with stocks you only pay capital gain taxes when you sell with a gain. No capital gain distributions. With mutual funds you get those even during bad years.

Personally, I mostly have mutual funds in the "equities part" of 401K , but I have mostly ETFs and individual stocks in my taxable account - again the part that I have in stocks; I have a considerable percentage of my money outside of the market in both retirement and non-retirement funds.

Mike · 10 months ago

I should clarify about the cap gains - in theory ETFs should have little or no capital gain distributions. This would also be true of a mutual fund that never sold any holdings.

In practice - a broad-based ETF, say based on the S&P500 should be pretty stable but there are also a lot of more specific ETFs as well as ETFs that operate on some sort of automated strategy (ie dividend yield metric). The specific or partially managed ETFs are more likely to have capital gain distributions.

I don't think the tax efficiency is all that relevant when comparing an index fund to it's equivalent ETF since they should both have similar tax situations.

The fact is that you have to know what you are buying - "ETF", "mutual fund", "index fund" are just general labels - there is a lot of overlap with respect to how they are run. There is no reason someone can't start an ETF and just pick their favorite stocks. How is that different than a managed mutual fund?

Mike · 10 months ago

Mrs. Micah - you are correct about buying ETFs with automated trades. Sharebuilder allows for this - I should have mentioned it in the article but I guess I don't really consider them a "normal" brokerage. They are a perfectly legitimate choice for buying stocks however.

kitty · 10 months ago

@Mike - you are right, I was wrong, there could be capital distributions with some ETFs. At least in terms of shares sold by the manager. However, there is a difference in how index funds and ETFs handle redemptions. In ETFs investors are insulated from the selling of shares by other investors in the fund. This is especially important in the market like we had last year.

frugalCPA · 10 months ago

That was really helpful. Thanks!

rhysm · 10 months ago

Thanks, this helped explain the difference(s).

BetaDocuments · 10 months ago

Hi,

This is first time I have visited your site. Really Great, thanks for sharing information. If you dont mind, is there a chace that you can share with all your readers, what are you currently invested in. Exactly what percentage of ETF's, stocks and T-Bills if any. Market in 2007 and 2008 combined lost almost 50% of its value. What are you invested in that you have not seen such impact. I will be really really looking forward to see, how your portfolio looks like.

Thanks once again for sharing your finances.