Name: Index Funds vs. ETFs vs. Mutual Funds: Which Is Best?
Uploaded: 2024-07-28T07:45:41.000Z
Duration: 12 min 34 s
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Vanguard index funds, ETFs, and mutual funds.

The subjunctive

The more you look into it, the more you realize that they have quite a bit in common, but are all very different.

I've gotten a ton of questions about the differences recently, and it's become very obvious that there's some confusion around what they are and how they work.

Makes sense why it's tough to understand them though, because they are more intertwined than a group of swingers, yet as different as a piece of art by Banksy and the drawing that I just did 20 minutes ago.

The best way to understand this whole thing is to show you an overview of how they all work together.

So I drew you a picture and broke down each part by level.

Feel free to pause the video to get a visual or take a screenshot before we dive in.

The whole process starts at level one with an index.

An index is just a group of investable assets that measures the overall performance of those assets combined.

Major indexes are the ones that a lot of people have heard of.

The Dow Jones, the NASDAQ, Russell 2000, or the S&P 500.

For example, the S&P 500 is made up of the 500 largest U.S. companies publicly traded on the stock market.

But you cannot invest in these indexes directly because you'd need some sort of index fund to do that.

But I'm getting ahead of myself since we'll talk about that in level four.

At level two, we have our index providers, sometimes referred to as benchmark providers.

Think of these people as the data collectors of the different indexes.

They take all of the data that has to do with these indexes, put it together, and package it in a way that's nice, neat, and presentable.

The five major index providers are the Center for Research and Security Prices, Standard & Poor's, Morgan Stanley Capital International, Russell U.S.

Indexes, and the Dow Jones Industrial Average.

Each of these providers will take all of this presentable data, then create index products that they're willing to sell to index fund creators like Vanguard.

You cannot invest directly with these companies, so that's why you need a Vanguard to create an investable product for you to put your money into.

Vanguard is the company that creates specific funds for you to invest in using the index data that one of these index providers offers.

Think of Vanguard like the middleman between you and the index provider.

Now we've made it to level four, where Vanguard would decide that they wanted to create an index fund that tracks a specific index.

To do that, Vanguard needs to decide on what the goal would be for a specific index fund.

If the goal is to track the total U.S. stock market, then they need to figure out which one of these five benchmark companies offers a product that meets the criteria Vanguard is looking for for this specific index fund that they wanna create.

Sometimes these different index providers offer competing products, so it's up to Vanguard to decide which one they wanna use for their index fund.

Total Stock Market Index Fund, VTSAX, it's tracking the CRSP U.S.

Total Market Index, which is a product offered by the Center for Research in Security Prices.

When you invest in this type of fund, your money is being spread among every U.S. stock available.

In my three-fund portfolio video, I go through the benefits of index-based funds, so I'll have a link to check out that video down in the description and at the end of this video as well.

For the Vanguard S&P 500 Index Fund, VFIAX, Vanguard has chosen to track the S&P 500 Index, which is a product offered by S&P Dow Jones Indices.

If you're getting some value from this video, please help support my dog, Molly, and of course this channel by hitting that thumbs up button.

Vanguard isn't making a one-time purchase of these products from the index providers though.

Since stock prices and market caps are constantly moving, each Vanguard fund will pay an ongoing licensing fee to the index provider to ensure that they have the most up-to-date information.

When there are any changes within each index a fund is tracking, Vanguard will handle adjusting the fund accordingly so you don't have to do anything.

For example, Netflix was in the top 10 of the Vanguard S&P 500 Index Fund for a little while.

Now, since the stock price had plummeted over time, it fell out of that top 10.

Now, the index provider communicated that info to Vanguard so they could make this adjustment within their index funds.

I just threw a whole bunch of info at you, so let's recap before moving on to mutual funds and ETFs.

At level one, we have the overall index like the S&P 500, the NASDAQ, and the Dow Jones.

Then at level two, we have the index slash benchmark providers that create different products that track these indexes.

At level three and four, we have Vanguard who will license these index tracking products from one of these index providers to create their index funds.

Level five is going to be made up of both mutual funds and or ETFs.

Once Vanguard has decided on an index fund, they can choose to either wrap that fund up within a mutual fund or ETF structure for investors to purchase.

These two structures behave differently, which we'll cover in a minute, but it's good to note that both can be made up of the same index fund.

This is why I say to think about a mutual fund and ETF as two different types of wrappers to go around the same piece of candy, or in this case, index fund.

We're going to do a quick breakdown separately, then we'll compare both of them next to each other based on expense, minimums, tax efficiency, and a ton of other factors that will help give you a better understanding.

A mutual fund wrapper is an investable asset that allows you to spread your money among many different stocks, bonds, or any other asset it chooses.

There is a big difference between actively managed mutual funds and index-based mutual funds, sometimes referred to as passively managed mutual funds.

Vanguard offers three different types of mutual fund structures, institutional shares, admiral shares, and investor shares.

The institutional shares are usually going to be used by large employer programs like a 401K, HSA, or 403B because the minimum amount to invest is higher.

By higher minimum to invest, I'm talking in the $5 million or even $5 billion range.

The next type of mutual fund share class they offer that is available to you as an individual investor is called investor shares.

These investor share mutual funds are going to be where a lot of their actively managed funds exist.

Actively managed mutual funds are where fund managers are actively choosing which stocks to buy and sell on a regular basis.

They are not investing like an index fund is, so do not get these two mixed up.

I am not a big fan of actively managed funds, but if you enjoy high fees as well as increasing your odds of underperforming the market, then have at it.

The third type of mutual fund Vanguard offers is their admiral shares.

This mutual fund wrapper is where most of their index funds are going to exist.

The admiral shares usually offer the lowest fee options.

An exchange-traded fund is the second wrapper that can be placed around an index fund to be bought and sold by average investors like us.

As with mutual funds, when you invest in an ETF, your money is being spread among all of the different stocks, bonds, or other assets held within that ETF.

Some Vanguard mutual funds also have matching ETFs.

For example, the Vanguard Total Stock Market Index Fund has a mutual fund slash admiral share version, which is VTSAX, and it also has an ETF version, which is VTI.

Exact same index fund, but with a different wrapper, and I'm not talking about Snoop Dogg.

Same thing with the S&P 500 Index Fund, where the mutual fund slash admiral share version is VFIAX, and the ETF version is VOO.

Not all Vanguard mutual funds have a matching ETF, and not all Vanguard ETFs have a matching mutual fund, but pretty much all of their index funds have both a mutual fund and ETF version.

Now let's compare the Vanguard mutual fund and ETF wrappers to show you where the differences are.

Remember that we're comparing these two wrappers that index funds come in.

The Vanguard mutual funds can only be bought and sold at the end of each trading day.

So if you place a trade to buy or sell a mutual fund anytime before 4 p.m.

Eastern Standard Time, then the transaction won't actually go through until the stock market has closed for the day.

ETFs can be bought and sold anytime while the stock market is open, just like if you were buying and selling an individual stock.

Vanguard mutual funds come with an investment minimum, which is around $3,000, while there isn't a minimum needed to invest in their ETFs.

Vanguard mutual funds can be purchased on their investment platform for free.

Now, if you wanna purchase these funds on another platform like Fidelity, then they'll charge you a transaction fee between 50 and $75.

You can purchase the Vanguard ETFs on any platform like Fidelity, Charles Schwab, Robinhood, or my favorite, M1 Finance, with no added fees.

Do not, I repeat, do not buy Vanguard mutual funds on any platform except Vanguard, because it's not worth paying the extra fee.

Now, if you insist on buying Vanguard funds on a different platform, then just buy the comparable ETF if it's available.

You are able to transfer Vanguard mutual funds to other brokerages like Fidelity, and they will not charge you a fee.

Same with Vanguard ETFs, there are no fees.

If you own Vanguard mutual funds on the Vanguard platform and they have a corresponding ETF, then you can actually exchange them for the ETF version if you'd like, and it will not be a taxable event.

But you cannot turn the ETF back into the mutual fund version, so keep that in mind.

The cost for a mutual fund is generally a little higher than an ETF.

Now, if we're talking about the index fund version of both, then the price is going to be very close.

With the Vanguard mutual funds, you are able to purchase fractional shares.

With the Vanguard ETFs, you cannot purchase fractional shares on the Vanguard platform, but you can buy fractional shares of ETFs on most of the newer platforms like M1 Finance.

Generally, ETFs are more tax efficient because they distribute less and sometimes zero capital gains compared to a mutual fund.

Vanguard is a little different in this area because of a special patent that they have that's only valid until 2023.

This patent allows their mutual funds with a corresponding ETF to be more tax efficient than a normal mutual fund you buy from another provider.

Here's how Bloomberg described the process.

Vanguard attaches a more tax efficient ETF to an existing mutual fund.

Then the ETF siphons appreciated stocks out of the mutual fund without incurring taxes.

So the Vanguard mutual fund VTSAX is more tax efficient because it has a matching ETF, which is VTI.

If you want more info on other Vanguard investment topics, then I'll have that playlist linked to your left.

Make sure to hit that thumbs up button before you go and support this video's sponsor, Masterworks down in the description below as well.

 I'll see you in the next one, friends, done.