Vanguard ETFs vs Mutual Funds: Which Make for Better Investments?

If a frugal friend ever gives you an investing tip, it's likely they'll point you toward Vanguard exchange-traded funds (ETFs) or mutual funds. Vanguard is one of the largest and lowest-cost fund providers in the U.S. – and, in fact, their push to lower fees has actually helped bring fund costs down industry-wide. 

But even if your heart is set on Vanguard, you might be asking yourself: Vanguard ETFs vs Vanguard mutual funds, which is the better investment?

The answer, as it almost always is when it concerns investing, is "it depends."

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A brief history of Vanguard

Vanguard's history goes back to 1929, with the Wellington Fund – which still exists today, offered at Vanguard as both Investor Shares (VWELX) and Admiral Shares (VWENX). But the company itself didn't exist until 1975, when John C. Bogle founded The Vanguard Group. 

At the end of that same year, Vanguard launched the First Index Investment Trust – the first index fund, which would later be rebranded the Vanguard 500 Index Fund (VFIAX). Today, VFIAX boasts more than $900 billion in net assets to make it one of the largest mutual funds by assets.

Back then, index funds were a radical concept: trusting a fund's assets to the performance of a benchmark rather than a team of professional managers. But clearly, the investing world saw their incredible value, as index funds now command trillions of dollars in assets worldwide.

Vanguard ETFs vs mutual funds: What's the difference? 

The difference between Vanguard ETFs vs Vanguard mutual funds comes right down to the differences between all ETFs and mutual funds.

At a very basic level, mutual funds and ETFs operate the same way. Investors give their money to a provider in exchange for a small piece of ownership in the fund. Fund management then spends that money buying stocks, bonds and/or other assets depending on the fund's goals. You enjoy any capital gains and/or dividends paid, but you also suffer when the fund drops in value.

However, mutual funds and ETFs have some significant differences.

Mutual funds only trade once per trading day – after the market close. When you buy a mutual fund, you can spend any amount of money over the required minimum to buy shares – fund minimums run the gamut, from $0 to $50 to $1,000 to $1 million, and everywhere in between. You'll virtually always pay management fees (calculated as a percent of your investment, charged annually and taken directly out of performance), and occasionally other fees such as front-end sales loads (taken out of your initial investment) or redemption fees (fees charged when you sell your shares). On the back end, they're structured in such a way that they can generate capital gains taxes from the buying and selling of assets within the fund.

Exchange-traded funds, as the name suggests, trade on exchanges just like stocks, so you can buy them during normal and extended stock market trading hours. There is no minimum investment – you can buy as little as one share, usually in the tens or hundreds of dollars. (And if your brokerage has fractional shares, you can spend as little as $1 to buy part of an ETF.) 

ETFs only charge management fees. And their back-end structure, which involves in-kind creation and redemption of ETF units, helps minimize capital gains tax liabilities.

Exchange-traded funds tend to be cheaper than mutual funds for several reasons. One, as mentioned above, they only charge management fees. Two, their management fees tend to be cheaper than comparable mutual funds. And three, most ETFs tend to be index funds, which in general cost less to operate than actively managed funds, while most mutual funds tend to have human managers.

But let's be clear: There are actively managed ETFs, and there are index mutual funds, too.

One neat thing about Vanguard is that several (but not all) of their mutual funds are also offered as ETFs. And that comes into play when deciding between Vanguard ETFs vs mutual funds.

Why choose a Vanguard ETF over a mutual fund?

A Vanguard ETF is a better choice than a Vanguard mutual fund in two very common circumstances:

You have less than the minimum required investment to own the mutual fund. Popular Vanguard funds like the Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) and the aforementioned VFIAX have $3,000 investment minimums. So if you only had, say, $2,000, you couldn't invest in either.

But you could buy eight or nine shares of the Vanguard Total Stock Market ETF (VTI), which is floating around $215 per share right now, or four or five shares of the Vanguard S&P 500 ETF (VOO), which currently trades around $400.

Vanguard offers both ETF and mutual fund versions of a fund, and the ETF version is cheaper. Even if you can afford the investment minimum for a Vanguard mutual fund, you're typically going to absorb fewer fees by purchasing the Vanguard ETF instead. This is most often the case for Vanguard's indexed products. 

For instance, VTSAX charges a skinflint 0.04% expense ratio, or a mere $4 for every $10,000 you invest. But its ETF counterpart, VTI, charges just 0.03%. That extra $1 savings on $10,000 invested might seem trivial, but when all else is equal (and it is here), always take the cheaper fund. Those savings add up.

Why choose a Vanguard mutual fund over an ETF?

There are two very clear instances in which you would buy a Vanguard mutual fund over a Vanguard ETF:

You're interested in a Vanguard mutual fund that doesn't have an ETF counterpart. Several Vanguard funds, such as Vanguard Wellington – an actively managed fund that invests in both equities and fixed income – don't have ETF versions. So if you want Wellington, you have to buy the mutual fund.

You're investing in a 401(k) or other retirement plan (like some SEP IRAs) where plans are limited to mutual funds. While you can buy ETFs in virtually any brokerage account you can find, not all investment accounts allow for them. Most 401(k)s have largely rebuffed the ETF trend, and depending on your provider, some other retirement accounts might not allow for them. (Vanguard, for instance, only offers mutual funds in multi-member SEP IRAs.)

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• Vanguard Money Market Funds: What You Need to Know
• How to Find the Best Mutual Funds for Beginners
• How to Start Investing In the Stock Market: A Beginner's Guide