Forget about what I said about having both Vanguard mutual funds and ETFs. Vanguard just announced they lowered the minimum investment requirement for Admiral shares in most broad index funds from $100,000 to $10,000.
Admiral shares are a different share class in the same Vanguard fund but with a lower expense ratio. In most funds that offer both Admiral shares and ETF shares, the expense ratio on Admiral shares is about the same as the expense ratio on ETF shares. Only 16 out of 30 Vanguard index funds offer Admiral shares. See list here.
With the new lower hurdle, it no longer makes sense to hold both mutual fund shares and ETF shares in the same Vanguard fund. If you invest in Vanguard funds and you prefer the simplicity of open-end mutual funds, just buy Admiral shares.
If you currently hold more than $10,000 in a Vanguard mutual fund that also offers Admiral shares, you can convert to Admiral shares. It’s really simple. I did it online in my own account yesterday.
Click on a fund name in the account. Then look for "Convert shares of this fund to Admiral shares" on the right hand side. A few more mouse clicks later, you are done.
In a taxable account, conversion to Admiral shares isn’t a taxable event. It’s different from selling investor shares and buying Admiral shares. Still, you may have to do some housekeeping for tracking the cost basis. It will depend on which IRS-approved basis tracking method you are currently using.
Vanguard uses this method by default. After you convert to Admiral shares, Vanguard will continue tracking your average basis and sending you average cost statements when you sell any shares in any year.
The average basis method isn’t as flexible in minimizing capital gains when you sell. I also don’t like replying on someone else for tracking my basis for tax purposes. Tracking cost basis is ultimately a taxpayer’s own responsibility. Vanguard is only doing it as a service. It will be big headache if Vanguard decides to discontinue the average cost service. It will also be a pain if you decide to move your shares somewhere else for whatever reason.
However, if you used average cost when you sold shares in the same fund in the past, you are stuck with it. Pray that Vanguard will do it forever and do it correctly.
FIFO or Specific Share Identification
If you use either the first-in-first-out (FIFO) or the specific share identification method, you should have your own records of every purchase. They may be in a financial software like Quicken or Microsoft Money, or they may be just in a spreadsheet.
You will need the conversion ratio between new shares and old shares. The conversion ratio is the inverse of the net asset values (NAVs) of the two share classes. In some funds, the NAVs of investor shares and Admiral shares happen to be exactly the same. In those cases, you are lucky and you can skip the adjustment step. The conversion ratio is exactly 1:1.
It’s a little more involved when the NAVs are different. For example, if you converted Vanguard Large Cap Index Fund from investor shares (VLACX) to Admiral shares (VLCAX) yesterday, the net asset value (NAV) for the two share classes were $21.37 and $26.72 per share respectively. Therefore every 2,672 shares in investor shares would convert to 2,137 shares in Admiral shares. The conversion ratio is 2,137 / 2,672 = 0.7997754 Admiral shares for each investor share.
If you use Quicken, you enter a new transaction of type "Corporate Acquisition (stock for stock)." You put investor shares as the "Company acquired", Admiral shares as the "Acquiring company", and the conversion ratio 0.7997754 as the "New shares issued per held share" number.
If you use Microsoft Money, you right click on the investment, do a "Split Shares" and enter a split of 2137 shares for 2672 shares. After splitting the shares, you change the ticker symbol for the fund.
If you use a spreadsheet, you multiply the number of shares for each purchase by the conversion ratio 0.7997754 and divide your per share purchase price by the same number.
If you converted mutual fund shares to ETF shares, the process for making adjustment to cost basis tracking is exactly the same as outlined above.