The Vanguard Edge with Mutual Funds and ETFs

By Russell Wild

If you own a Vanguard mutual fund and you want to convert to the Vanguard ETF that tracks the same index, you can do so without any tax ramifications.

The conversion is tax-free because you will actually be exchanging one class of shares for another class of shares, all within the same fund. You can do this only with Vanguard ETFs. Vanguard actually has a U.S. patent that gives it a monopoly on this share structure.

For example, if you own shares in the Vanguard Total Stock Market Index Fund (VTSMX), and you decide that you want to exchange them for the Vanguard Total Stock Market ETF (VTI), you can do so and not worry about having to take any tax hit.

So should you do it? The expense ratio on the mutual fund is 0.18. The expense ratio on the ETF is 0.07. If you have, say, $20,000 in the account, moving from the mutual fund to the ETF will save you $22 a year in management fees. And the conversion may also possibly save you a dollar or two a year in taxes.

It would be worth your trouble to make the exchange only if you were looking to keep your investment for more than a couple of years.

Note that the tax-free transfer works in only one direction. If you have ETF shares that have appreciated in value, you can’t convert them to mutual fund shares without incurring a taxable gain (unless you hold them in a retirement account).