Exchange-traded funds, or ETFs, have become extremely popular investments, as they combine the ease of investing that you get with mutual funds with the simple-to-buy nature of stocks. One of the most popular, and lowest-cost, ETF issuers is Vanguard, which currently offers a selection of 56 ETFs that allow investors to put their money to work in a variety of stock and bond investments.
Here’s an overview of ETF investing that you may want to read before you get started, as well as a complete guide to the ETFs Vanguard currently offers.
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What is an ETF?
An exchange-traded fund, or ETF, is a type of investment that combines some features of mutual funds with some features of stocks.
Like a mutual fund, an ETF is a pool of investors’ money that is professionally managed in a manner consistent with the fund’s objectives. In other words, ETFs allow investors to spread their money around and to invest in assets like stocks without the research and risk involved in choosing individual stocks to buy.
Unlike mutual funds, however, ETFs trade on major stock exchanges. When you buy a mutual fund, you can enter your order at any point, but orders are processed only once per day — generally after the market’s close. ETFs, on the other hand, can be purchased virtually instantaneously just like a stock, and you’ll know the exact price you’ll pay per share when you invest.
ETFs are available for stocks, bonds, commodities, and many subcategories of each of these assets. For example, you can buy an ETF that invests exclusively in mid-cap U.S. stocks, or in international high-yield bonds. You can choose an ETF whose investments are actively chosen by professional managers or an ETF that simply tracks a certain index, such as the S&P 500. (More on these options in a bit.)
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ETF expenses
There are two key expenses investors should be aware of before buying their first ETF investment: the expense ratio and potential trading commissions.
An expense ratio is the investment fee that pays for the fund’s managers and the administrative costs of running the fund. Expense ratios are expressed as a percentage of the fund’s total assets under management, or AUM. For example, a 1% expense ratio means you’ll pay $10 in investment fees per year for every $1,000 you have invested in the ETF or mutual fund. Expense ratios can vary significantly, even among funds that essentially invest in the same things, so it’s important for new investors to shop around.
The second major cost associated with ETF investing is trading commissions. This is one potential downside of ETF investing as opposed to mutual funds. Because they trade on major stock exchanges, most ETF transactions are assessed a trading commission, just as if you had bought a stock. These can also vary significantly between brokers, so if you’re a new investor, it’s a good idea to shop around.
Many brokerages have some sort of “commission-free ETF” program, whereby a certain selection of ETFs can be traded with no commissions. These programs are constantly evolving, and the lists of included ETFs change over time, but as of this writing, it’s difficult to find Vanguard ETFs in a commission-free program offered by a major brokerage. However, you can avoid commissions on Vanguard ETFs by opening an account and buying the ETFs directly through Vanguard.
Index funds versus actively managed ETFs
I briefly mentioned this earlier, but there are two main types of ETFs — actively managed ETFs and passively managed ETFs (also known as index funds).
Actively managed ETFs employ investment managers to invest the funds’ assets and to maintain the underlying investment portfolio. The goal of actively managed ETFs is to beat the market over time, although in practice, most actively managed ETFs don’t. In fact, a report from S&P Dow Jones Indices found that less than 8% of large-cap active mutual fund managers beat their benchmark indices over the past 15 years, and the numbers were even worse for mid- and small-cap funds. However, because of the increased work involved in operating actively managed funds, they nonetheless tend to have relatively high expense ratios.
While there are tons of actively managed mutual funds, most ETFs fall into the passively managed, or index fund, category. These are funds that simply aim to match the performance of a certain index by investing in the index’s components. For example, an S&P 500 Index ETF would invest in the 500 stocks that make up the S&P 500, and in the proportional amounts. Because there is no “stock-picking” involved with index fund investing, passively managed index funds tend to have relatively low expense ratios.
Tax implications of ETF investing
No discussion of ETF investing (or any other kind of investing) would be complete without mentioning the potential tax implications. So here are the general principles that are important to know.
Profits you make on the ETF shares themselves aren’t taxed until you sell. Even if the shares of an ETF you buy rise from $10 to $500, you won’t owe the IRS a dime until you sell. If you hold the ETF for more than a year, any profits you make on the sale of the shares will be taxed as long-term capital gains, which are subject to a lower tax rate than ordinary income. On the other hand, if you hold the ETF for a year or less, any profits will be taxed as short-term capital gains, which are taxed at your ordinary marginal tax rate, or tax bracket.
However, dividends paid by ETFs are taxable in the year in which they are received. Most ETF dividends can meet the favorable tax definition of qualified dividends, which are taxed at the same rate as long-term capital gains. There are a few exceptions, however. Some international and commodity ETF distributions don’t get favorable tax treatment, for example. Fortunately, your broker will make this easy for you. Each year, you’ll receive a 1099-DIV tax form that will display the precise classification of the dividends you’ve received.
Finally, if you hold your ETFs in an IRA or other tax-advantaged account, you can ignore the previous rules in this section. If you hold your ETFs in a traditional IRA or other tax-deferred account, you won’t have to worry about capital gains or dividend taxes, but any eventual withdrawals from the account will generally be treated as taxable income. And if you hold your ETFs in a Roth IRA, you won’t have to pay any tax at all on capital gains, dividends, or withdrawals.
Why Vanguard ETFs?
Vanguard and its founder, John Bogle, are considered to be pioneers of index fund investing. Bogle believes index funds are the most efficient ways for most people to invest, so he and Vanguard developed an extensive portfolio of index funds that charge some of the lowest expense ratios in the market. And as I mentioned earlier, if you buy these ETFs directly from Vanguard, you won’t pay a dime in trading commissions.
Simply put, Vanguard ETFs let investors get exposure to a variety of investments without having large investment fees eat away at their returns.
A guide to Vanguard’s ETFs
Vanguard has a huge menu of ETFs that investors can buy, so here’s a complete guide to the available Vanguard ETFs as of July 2018. We’ll break them down into asset category, and within each asset category, we’ll break them down further into more specific types of investments.
For each Vanguard ETF, we’ll look at its expense ratio, dividend yield (as of this writing), and subcategory of investment.
Vanguard U.S. stock ETFs
As of July 2018, Vanguard offers 17 different ETF products focused on U.S. stocks. These can be further broken down by the size of companies they invest in — large-cap, mid-cap, or small-cap.
We’ll also designate each ETF as a growth ETF, value ETF, or blend ETF. In short, a growth ETF invests in stocks with above-average growth rates, value ETFs invest in stocks with below-average valuations, and blend ETFs invest in a combination of the two.
Vanguard large-cap U.S. stock ETFs
These funds invest in the largest U.S. public companies. The flagship large-cap stock fund in Vanguard’s product portfolio is the S&P 500 ETF, which has a rock-bottom 0.04% expense ratio and has nearly $420 billion in total assets under management.
It’s also worth noting that the megacap funds invest in the largest of the large U.S. companies, so these could be a good choice for investors who don’t mind giving up a bit of diversification to invest in only extremely large companies.
Vanguard mid-cap stock ETFs
These funds invest in midsize companies, which are generally defined as those with market capitalizations of $2 billion to $10 billion, although there are some companies included in these ETFs that have significantly higher market caps.
Vanguard small-cap stock ETFs
These ETFs invest in small-cap stocks, which are generally defined as having a market cap of less than $2 billion. Small-cap stocks tend to be more volatile than either large-caps or mid-caps, but they also tend to deliver superior returns over long time periods, which makes them a compelling option for investors with long time horizons.
Vanguard international stock ETFs
There are three main types of international stock ETFs — global, international, and emerging market. Global stock ETFs invest in stocks from all around the world, including the United States. International stock ETFs invest in stocks from all around the world except the United States. Emerging-market ETFs invest in stocks from developing nations, such as China, Brazil, Russia, India, and others.
Out of the 11 international stock ETFs Vanguard offers, nine of them are purely international stock ETFs. Of the other two, one is a global ETF, and the other is an emerging-markets ETF.
There are a few good reasons why investors might want to add international stock exposure to their portfolio. For starters, it adds an element of diversification. International stocks reduce your exposure to any single nation’s economic issues and also help to hedge against currency fluctuations. Also, certain areas of the world, particularly emerging markets, have more compelling long-term growth potential than the U.S. and other developed nations.
Vanguard sector ETFs
Vanguard’s sector ETFs are stock-based ETFs that invest in indexes tracking specific sectors of the market. There are 11 S&P-defined sectors in the market, so it makes sense that Vanguard offers 11 sector ETFs.
Sector ETFs allow investors to put their money to work in a certain part of the market — say, bank stocks — without the risk and homework involved in choosing individual companies to invest in. In other words, if you think the banking business as a whole will perform well, then a financial-sector ETF could be a smart way to invest.
Vanguard U.S. bond ETFs
While stocks certainly tend to produce the highest returns over long time periods, they are also relatively volatile over shorter periods. Therefore most experts suggest that investors allocate their investment assets to an age-appropriate combination of stocks and bonds.
Vanguard offers 15 different ETFs focused on U.S. bonds, and these can be split into four main categories: government bonds, investment-grade corporate bonds, a blend of government and investment-grade corporate bonds, and tax-exempt bonds.
Vanguard government bond ETFs
Government bonds, such as Treasuries and agency mortgage-backed securities, tend to pay relatively low dividend yields when compared with corporate bonds, but it’s important to realize that these investments also have significantly lower risk, especially when it comes to risk of default. However, it’s important to mention that all bonds (especially the longer-dated ones) can fluctuate significantly in terms of market price over time.
Vanguard investment-grade corporate bond ETFs
Corporate bonds pay relatively high interest rates, but they also have a higher risk of default than government bonds. To be clear, these Vanguard ETFs all contain investment-grade bonds, which generally have minimal (but not zero) default risk.
Vanguard blended U.S. bond ETFs
For investors who want exposure to both corporate and government bonds, these four Vanguard ETFs can allow you to do that without buying two separate funds.
Vanguard’s tax-exempt bond ETF
Most municipal bonds are exempt from federal (and often state) taxes, so they’re a favorite among investors who hold their investments in taxable brokerage accounts and are in relatively high tax brackets.
For example, for an investor who is in the 37% marginal tax bracket, a 3% tax-free yield is equivalent to a 4.76% pre-tax yield. So these can be great choices for the right type of investor, and Vanguard offers one ETF that focuses on tax-exempt bonds.
Vanguard international bond ETFs
For investors who want to get some geographic diversification within their bond portfolios, Vanguard offers two international bond ETFs. The first tracks an index of international bonds — that is, bonds from countries around the world other than the United States. And the second tracks an index of bonds issues by governments of emerging nations around the world, which is a bit higher-risk but also has the highest yield of any Vanguard bond ETF.
Vanguard ETFs: Simplified investing without high fees
Vanguard ETFs have been extremely popular among investors because of their low-fee approach to simplified investing. As you can see here, there are Vanguard ETFs designed to fit into a variety of investment goals and objectives. If you want to invest the easy way while keeping your costs as low as possible, Vanguard ETFs can be a smart way to do it.
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