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At the risk of beating a dead horse, I am still confused about the benefits of an ETF over a mutual fund.

I understand the general premise (lower expense ratio, liquidity, paying taxes for other people, etc...), but it seems to me that it doesn't hold up when examining specific head to head examples...

For instance, let's take Vanguard S&P 500 fund (VFIAX) vs equivalent Vanguard S&P 500 ETF (VOO).

Both have 0.05% expense ratio, so that's a wash...
Since they both track S&P 500, there are no sudden stock sales that would have me paying taxes for stocks bought eons ago.

Why would I invest an ETF vs Mutual Fund (or vice versa) in this case?

3 Answers 3

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There are times when investing in an ETF is more convenient than a mutual fund.

When you invest in a mutual fund, you often have an account directly with the mutual fund company, or you have an account with a mutual fund broker. Mutual funds often have either a front end or back end load, which essentially gives you a penalty for jumping in and out of funds.

ETFs are traded exactly like stocks, so there is inherently no load when buying or selling. If you have a brokerage account and you want to move funds from a stock to a mutual fund, an ETF might be more convenient.

With some accounts, an ETF allows you to invest in a fund that you would not be able to invest in otherwise. For example, you might have a 401k account through your employer. You might want to invest in a Vanguard mutual fund, but Vanguard funds are not available with your 401k. If you have access to a brokerage account inside your 401k, you can invest in the Vanguard fund through the associated ETF.

Another reason that you might choose an ETF over a mutual fund is if you want to try to short the fund.

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Something to consider is how do you want to handle fractional shares. Most open-end funds can easily go to fractional shares to that if you want to invest $500 in a fund each month, it is a relatively easy transaction where some shares will be fractional and handled easily. An ETF may not always work that way unless you go through something like Sharebuilder that would allow the fractional shares as if the ETF is trading at $150/share, you could buy 3 shares but still have $50 that you want to invest but can't as stocks trade in whole share numbers usually. This is without adding brokerage commissions. Depending on the broker, re-investing dividends may or may not be that simple as fractional shares could be a problem since those 3 shares aren't likely to have enough of a dividend to equal another share being bought with the proceeds.

If you want the flexibility of stop and limit orders then the ETF may make more sense while the open-end fund is simply to invest whole dollar amounts that then lead to fractional shares. Don't forget to factor in minimums and other stuff as VFIAX may have a bit of a minimum to it as well as possible fees that could be annoying as I remember VFINX having some account maintenance fees that were a bit irksome back in the day that may still be around in some cases so be sure to read the fine print on things.

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In the case of VFIAX versus VOO, if you're a buy-and-hold investor, you're probably better off with the mutual fund because you can buy fractional shares. However, in general the expense ratio for ETFs will be lower than equivalent mutual funds (even passive index funds). They are the same in this case because the mutual fund is Admiral Class, which has a $10,000 minimum investment that not all people may be able to meet. Additionally, ETFs are useful when you don't have an account with the mutual fund company (i.e. Vanguard), and buying the mutual fund would incur heavy transaction fees.

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