If you are invested in Vanguard mutual funds, you might have been confused by their recent announcement of free trades for Vanguard ETFs for in-house brokerage customers. One consequence of this is that it makes it more attractive for many folks to convert their existing mutual funds to their respective ETF versions. Here’s what the Vanguard website has to say about it:

Can I convert conventional Vanguard mutual fund shares to Vanguard ETFs?

Shareholders of Vanguard stock index funds that offer Vanguard ETFs may convert their conventional shares to Vanguard ETFs of the same fund. This conversion is generally tax-free, although some brokerage firms may be unable to convert fractional shares, which could result in a modest taxable gain. (Four of our bond ETFs—Total Bond Market, Short-Term Bond, Intermediate-Term Bond, and Long-Term Bond—do not allow the conversion of bond index fund shares to bond ETF shares of the same fund; the other eight Vanguard bond ETFs allow conversions.)

There is no fee for Vanguard Brokerage clients to convert conventional shares to Vanguard ETFs of the same fund. Other brokerage providers may charge a fee for this service. For more information, contact your brokerage firm, or call 866-499-8473.

Once you convert from conventional shares to Vanguard ETFs, you cannot convert back to conventional shares. Also, conventional shares held through a 401(k) account cannot be converted to Vanguard ETFs.

In my opinion, the main question to ask is if you wish to buy ETFs from now on. See the Vanguard ETF vs. Mutual Fund decision process. If so, then it’s probably a good idea to convert your existing mutual funds to ETFs as well, since there is no effect tax-wise.

However, technically you could just convert your mutual funds to ETFs for the annual expense ratio savings, and then continue on buying mutual funds. Depending on the fund, the annual savings could be significant. You’ll still avoid any redemption fees, like the 0.25% that the Vanguard Emerging Markets Index Fund (VEIEX) charges. Perhaps you really like dollar-cost-averaging a fixed amount in regular intervals ($100 every two weeks, etc.).

How To Do The Conversion at Vanguard

1. You’ll have to open a brokerage account with Vanguard, which is relatively straightforward. In the application, you’ll have to answer some employment questions and disclose any stock exchange affiliations. You’ll also choose a money market fund for your cash sweep account. See my Vanguard Brokerage opening process review for more details.
2. Next, you should log into your mutual fund account and record the cost basis for your mutual fund shares for tax purposes. Look for the blue “Cost Basis” link when looking at your portfolio holdings. Print that page out for your records, so you know what you paid for your current holdings.
3. Finally, you must call Vanguard and request the ETF conversion. (You can’t do it online.) The conversion will be done according to the net asset value (NAV) of the funds on the next available market close at 4pm Eastern. Approximately two days later, the new ETF shares should show up in your brokerage account. You will end up with partial shares, which can only be liquidated if you sell your entire position. It’s okay though, they still earn dividends and all that good stuff.