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
- 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.
- 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.
- 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.
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Not sure if I’m wording this correctly, but do you know if the current cost basis? For instance, if I convert a mutual fund that currently has a negative cost basis, does that carry over to the ETF or am I allowed to write it off my taxes? I assume no to writing it off because of the wash rules, but want to know if there are any tax consequences.
Is it possible to convert VEIEX in Roth IRA account to VWO? If so, what are fees associated with this transaction? What are the pros & cons? Please advise.
I recently converted the funds I could to ETFs at Vanguard, but it raises all kinds of interesting questions…
Question #1:
What is the most reasonable strategy for actually purchasing ETFs?
Question #2:
For the remaining funds that could not be converted (Total International), what is the most reasonable strategy for selling those funds and purchasing similar ETFs? (very similar to question #1!)
While this may not apply to some, if one has over $1 mil in funds invested with Vanguard, he/she is an Admiral class shareholder which generates significant cost savings that may negate the need to move to ETFs.
@Anonymous – The cost basis is simply what you paid for the mutual funds. What you paid for the mutual funds is what you essentially paid for the ETFs, if you convert. No tax difference. If your gains are negative, they’ll still be negative if you sell the converted ETFs.
@Lone – Yes, you can certainly do this in an IRA. The steps and fees are the same. Just open a brokerage account in IRA, and so on.
@Steve – Good question. Your 2nd question will depend on any unrealized gains and if you are willing to realize them now.
@Spokane Al – I think you mean $100k balance in each mutual fund, and yes, you are correct in many cases that the expense difference will be much, much smaller if any.
Sounds like a nice option. I however, have an automatic schedule set up to invest bi-monthly on payday into my IRA and taxable account so it doesn’t look like it is for me right now.
I mean you COULD convert to ETFs which would lower your maintenance costs of the fund, but do you REALLY believe that ETFs are actually instruments which can be truly diversified? So many of them work SO differently. It’s not really a matter of indexing.
Markowitz aint got nothing on ETF’s
Cheers
Michael
I am considering converting my Vanguard mutual funds to Vanguard ETFs, and was hoping someone could clarify the calculation of the cost basis for future tax purposes. I understand the need to record the cost basis of the mutual funds before conversion. After conversion, are you able to enter that cost basis into Vanguard, and have it automatically calculate your gains? In other words, after purchasing more shares of a given ETF, does it take into account the original cost basis + the cost basis of additional shares of the ETF? Thank you for your help.
@Jason – Yes, you enter the cost basis into Vanguard yourself after conversion.