Striking a balance between ETFs and mutual funds

For an advisor juggling the demands of numerous clients and trading platforms, there’s no one-size-fits-all approach

Striking a balance between ETFs and mutual funds

While ETFs have generally trounced mutual funds as investors’ preferred low-cost investment products, that doesn’t mean an all-ETF portfolio is always the best option. Aside from proper diversification, one has to consider people’s individual situations as well as platform-specific costs.

One advisor’s story illustrates that point. “It’s taken me six years of research, trials and errors but I think I’ve finally found the formula that works best for my practice,” said Dave Grant, founder of Illinois-based planning firm Retirement Matters, in a column for Financial Planning.

While Grant said he initially encouraged clients to use ETFs, he’d regularly face questions on how to adjust purchases when share prices changed or whether they should worry about bid-ask spreads. As a result of that, he suggested that they use passive mutual funds, mostly from Vanguard, which allowed him to advise clients on dollar amounts to invest without any hitches, provided they were over the investment minimum.

But clients who held accounts with Fidelity or Charles Schwab started encountering issues when their trading and ongoing expenses started to rise. “In response, I adjusted the approach and used index funds native to that custodian,” Grant said.

The wrinkles didn’t end there, however, as he had different portfolio models set up for various custodians; for most clients with multiple accounts held across multiple custodians, that led to complicated –looking investment recommendations. That changed in summer 2016, when Grant joined the XY Planning Network, gaining access to the TD Ameritrade platform without the need for a minimum asset base.

“With access to a custodian and being able to manage client accounts directly, my investment recommendations started to adjust back to a simpler, more holistic design,” Grant said. But by monitoring the diversification, costs, and tax efficiency of his clients’ investments, he realized that he was costing each client US$24 every time he bought and sold a Vanguard mutual fund on the TD Ameritrade platform.

“It bothered me that even in years of mediocre performance, my clients could experience short- and long-term gain distributions solely based on activity inside the mutual fund itself,” he said. After researching Vanguard’s ETF alternatives for the mutual funds in question, he found that they did not differ radically from their mutual-fund equivalents, had a lower expense ratio, and could be traded for free on the TD Ameritrade platform at the time.

Grant still had one more tweak to do. Recalling his favourable experience with Dimensional Fund Advisors at a previous firm, he underwent the firm’s advisor training and gained the ability to use its mutual funds. “I believed there had to be some arbitrage between some Vanguard ETFs and its DFA mutual fund competitor,” he said, clarifying that he still used Vanguard ETFs for most positions.

After looking into the long-term characteristics of asset classes offered within Vanguard ETFs and DFA mutual funds, he found that some DFA fund classes in emerging-markets debt and equity, and global real estate, were a better primary vehicle than Vanguard ETFs. Before making the changes to his clients’ portfolios, he gave them a backgrounder, including an explanation of the conferences and calls he’d attended in preparation.  

“Now my client portfolios have a mixture of Vanguard ETFs — clients get excited when they see their investments are almost free — and a smattering of DFA funds where it makes sense from an allocation and tax perspective,” he said.


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