ETF substitutes for my portfolio

Recently, I applied for the Wells Fargo Portfolio Management Account (PMA) so that I can take advantage of their 100 free trades offer per year for every linked account. The 100 free trades offer is very attractive as it would allow me to invest into ETFs or no-load funds (which previously have transaction fees) with no fees.

There are certain advantages in using ETFs instead of mutual funds; some of which are better tax efficiency, lower expense ratios and no redemption fee / trading restrictions. Currently, the core of my portfolio is invested in Vanguard mutual funds, but this could change in future as I am thinking of using more ETFs in my portfolio, especially for some of the more relevant asset classes.

I looked around to find the ETF vehicles of the asset classes that I currently hold. The following is the list for my equity asset allocation:

  • US Total Market : Mutual Fund = VTSAX (Vanguard Total Stock Market Index Admiral, ER = 0.09%), ETF = VTI (Vanguard Total Stock Market ETF, ER = 0.07%).
  • US Small-cap : Mutual Fund = VTMSX (Vanguard Tax-managed Small-cap, ER = 0.14%), ETF = VB (Vanguard Small-cap ETF, ER 0.10%) or IJR (iShares S&P 600 index, ER 0.20%, higher trading volume) in taxable account or VBR (Vanguard Small-cap Value ETF, ER = 0.12%) in tax-advantaged account.
  • US Real Estate : Mutual Fund = VGSIX (Vanguard REIT Index, ER = 0.21%), ETF = VNQ (Vanguard REIT ETF, ER = 0.12%) in tax-advantaged account only.
  • Int’l Emerging Markets : Already using ETF, which is VWO (Vanguard Emerging Market ETF, ER = 0.30%).
  • Precious Metal Equity : Mutual Fund = VGPMX (Vanguard Precious Metals and Mining, ER = 0.40%), Current poor substitue is Market Vectors Gold Miners ETF, GDX (ER = 0.50%).
  • Healthcare : Already using ETFs, which are IHF (iShares DJ US Healthcare Providers ETF, ER = 0.48%), PBE (Powershares Biotech and Genome ETF, ER = 0.6%) and XPH (State Street SPDR Pharmaceuticals ETF, ER = 0.36%).

10 Comments

  1. choozm

    Hi,

    Why are some ETFs “poor substitue”? Is it because of high ER? Or low trading volume?

    How about trading volume of these ETFs? Any problem with that?

    Reply
  2. indexfundfan (Post author)

    choozm, you guessed right. I don’t like the ETFs with higher ER, e.g. EFA. As for Wisdom Tree’s DLS, it is just using the latest fad — weightage by dividend distribution and is not a “true” index fund. Rick Ferri calls it Spindex.

    As for GDX, I think it deviates quite significantly from VGPMX — and I haven’t decided if I will take it up.

    Reply
  3. indexfundfan (Post author)

    I added information on all the expense ratios into the post. The case for EFA doesn’t look so bad actually, but I would still be interested to find out more on Vanguard’s upcoming all-world ex-USA offering.

    On US small-cap, IJR, which tracks S&P 600 index, might be a good option to VB (Vanguard small-cap index ETF) as it has a more respectable trading volume compared to VB.

    Reply
  4. choozm

    indexfundfan, how long would you observe after the Vanguard’s Int’l ETF starts trading? If you take a long time (one year?) to observe its volume or spread before you decide to invest in it, then the cash waiting to be invested will be idle, no? I am just thinking of similar problem should Lyxor lists broad based ETF in SGX.

    Reply
  5. indexfundfan (Post author)

    It depends. The duration will depend on a combination of the following:

    1. trading volume and liquidity (hopefully at least 100k shares traded everyday)
    2. Fund size (at least 50 million)
    3. tax efficiency / distributions (if possible)
    4. amount of expense ratios savings

    I wouldn’t be letting cash sit idle since I can still buy the mutual fund version in the tax-deferred account, and swap out into taxable account when I have decided on the ETF.

    Overall, my guess is that the wait is probably 3 to 6 months.

    Reply
  6. LostInRebates

    Hello:

    I am a big proponent of ETFs over Mutual Funds. But I have difficulty with Dollar Cost Averaging in ETF and so I still stick with Mutual Funds. Can you shed some light on your strategy for DCA? Thank you for your time.

    Reply
  7. indexfundfan (Post author)

    Hi LostInRebates,

    I am not sure how often and which broker do you use. But using a free-trade broker like those from Wells Faro or Zecco would help when using DCA with ETFs.

    Currently, I only have a limited number of ETFs (VWO, IHI, IHF and PBE); most of my money is still invested in mutual funds with Vanguard. As for my strategy, I maintain a spreadsheet showing the value of the funds in each asset class. Every month, I will look at which asset classes are ‘lagging’ and put my money into that one. This is a purely mechanical system which helps to remove emotion from the equation and helps me stay the course.

    Reply
  8. choozm

    indexfundfan,

    When you substitute your mutual fund holdings with ETFs, what do you plan to do with the existing mutual funds? Keep them? Or sell them to buy into ETFs?

    What are the concern when you switch-sell mutual funds to ETFs (cost, tax,… )?

    Reply
  9. indexfundfan (Post author)

    choozm,

    I would keep most of the mutual funds. At this moment, I am using ETFs for emerging markets (VWO) and healthcare. I am adding these using a no-commission brokerage.

    However, most of my investments are still held at Vanguard and their brokerage commissions are not competitive at all. I will let those remain in mutual funds.

    Reply
  10. Gerald

    Keep in mind that for Int’l Large-cap the EAFE index can be replicated with 2/3 VGK and 1/3 VPL with an ER of 18 bp…

    Reply

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