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Downside to Index ETFs?

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  • Downside to Index ETFs?

    My 401k options are horrible (all actively managed, exp ratios of 0.75% and higher), but I do have a brokerage option. The problem is that buying a mutual fund through the brokerage account is $35 per transaction. Conversely, stocks (ie ETFs) are only $6.95 per trade. I was thinking of doing Vanguard ETFs like the Total Stock Market (VTI) and Total International ETF (VXUS). What are the major downsides to doing this within a retirement account? Thanks.

  • #2
    No downsides whatsoever.  That's exactly what I always recommend if you have a brokerage window.  It can get a bit complex when you want a diversified portfolio that has multiple index funds because you need to rebalance it, but even that can be done if you take the time to figure out how to do it.  With ETFs there is more work when you have to constantly reinvest/rebalance (even the simplest portfolio).  However, for a small portfolio, ETFs provide the best way to diversify, while for a relatively large portfolio I prefer mutual funds because it is easier to manage.
    Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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    • #3
      I'm not sure if this is what Kon was referring to, but you can't purchase fractional shares of an ETF like you can with a mutual fund (and for the record, I would call that a downside). So if you contribute $200 to an ETF whose shares are $105 then you'd be able to purchase only one new share and your remaining $95 would be idling as cash until you could contribute more. This does not happen with mutual funds. I find this to be a very annoying feature (or lack thereof) with ETFs. (As an aside: one thing that robo-advisor Betterment does is fractional ETF shares).

      Bond fund ETFs have some issues enumerated here: whitecoatinvestor.com/why-you-should-avoid-bond-etfs/ so strongly consider avoiding them.

      Here are some other thoughts from WCI: https://www.whitecoatinvestor.com/mutual-funds-versus-etfs/

      I used ETFs up until recently when I moved my Betterment account to Vanguard. However, my wife and I will likely use her Fidelity brokerage window within her 403b to purchase for free a small-value ETF (non-Vanguard, so can't do for free within our Vanguard accounts) that best lines up with our IPS and serves our needs.

      ETFs are a solid option and given those ERs, a brokerage account using ETFs is likely your best option.

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      • #4
        If your mutual fund options within your 401(k) are poor, buying index ETF's through your brokerage option is probably the way to go. However, since you asked about downsides, there are definately some to consider.

        1) Commisions are typically per trade, so regular periodic investment is a lot more expensive than lump sum. also, spreading your investment among multiple ETF's is more expensive than buying a single ETF because of trading costs. This has the result of penalizing diversification.

        2) Needing to buy whole shares has already been mentioned, with the subsequent cash drag.

        3) Having to manually reinvest dividends can be a hassle/overlooked easily.

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