If you're a current shareholder in one of five


index funds that plans to offer new exchange-traded share classes, you will soon face a mild dilemma: Stick with what you have or switch to the new shares?

The primary difference between the two share classes is cost, and any possible savings probably aren't significant for most investors. But they're worth examining.

First, let's recap the details of Friday's announcement: The indexing mutual fund giant -- with $240 billion in index assets under management -- announced it will introduce a new share class on five of its existing index funds, which will allow active investors to trade these shares like stocks.

Vanguard's exchange-traded shares -- called


, for Vanguard Index Participation Equity Receipts -- will initially be launched on the following funds: the

(VFINX) - Get Report

500 Index fund, the

(VTSMX) - Get Report

Total Stock Market Index,

(VIGRX) - Get Report

Growth Index,

(VIVAX) - Get Report

Value Index and

(NAESX) - Get Report

Small-Cap Index. The funds will trade on the

American Stock Exchange


You'll have to wait a few months to get a closer look at the new class of

exchange-traded shares. They aren't expected to come out until sometime during the third quarter.

Free Switching

Typically, investors must pay a brokerage commission to buy and sell shares in other exchange-traded index products, such as


(SPY) - Get Report

, which track the

S&P 500

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, and the

Nasdaq 100

tracking stock

(QQQ) - Get Report

, better known as the



But Vanguard says that investors in the five funds can simply move their money into the new share class without paying a commission. However, investors who own shares of Vanguard indices in 401(k) plans cannot convert their shares. And Vanguard "reserves the right at any time in the future to impose a charge on conversion transactions or to limit or terminate the conversion privilege," says the prospectus. Also, Viper shares cannot be converted into traditional index fund shares.

For those making the conversion, the move from one share class to another should not count as a sale in the eyes of the

Internal Revenue Service

, says Vanguard. Thus, there would be no capital gains taxes. Think about it this way: You aren't selling one fund to buy another. Your money theoretically stays in the same pool.


Vanguard hasn't said what the expense ratios will be for the new exchange-traded shares, but they should be lower than those on existing index products. Exchange-traded funds cost less to operate because the shares are sold by brokers and other third parties rather than the fund companies themselves. Therefore, the costs of things like customer service are reduced.

Vanguard also faces some aggressive competitors in the exchange-traded-fund arena.

Barclays Global Investors

is expected to launch the first of its own exchange-traded funds -- called


-- at the end of this week. The annual expenses on Barclays' S&P 500 index will be 0.09%, compared with 0.18% for the Vanguard 500 Index Fund.

If you are a current shareholder of a Vanguard index fund, switching to the exchange-traded version could save you some money if you don't trade in and out of them. Although Vanguard has said these exchange-traded funds are made for short-term traders, nothing prevents you from buying and holding these shares for a long time.

Tax Advantages?

While Vanguard's exchange-traded shares offer some advantages over traditional mutual funds, they don't carry the same tax advantages as some other tradeable portfolios, like the QQQ.

In general, exchange-traded funds should make fewer capital gains distributions than regular index mutual funds because their underlying portfolios aren't as affected by the buying and selling of fund shares by investors. Exchange-traded funds can redeem shares in kind -- that is, with actual securities -- rather than by selling securities. It is the sale of securities that have increased in value that can trigger capital gains distributions. Plus, most investors will simply buy and sell existing shares of the funds among one another, which doesn't impact the actual holdings of the underlying portfolio.

However, Vanguard's exchange-traded shares are going to be merely an extension of the existing funds. You'll have one fund with two share classes. So if there's a taxable distribution for regular shareholders, it will also be felt by shareholders of the exchanged-trade share class.

But this shouldn't be a big concern for you. The fund rarely makes distributions, and when it has to sell shares, it sells higher-cost shares first. Gus Sauter, managing director of Vanguard's quantitative equity group, which oversees the firm's index funds, says that although more money left the 500 Index fund in March than came in, it didn't realize any capital gains. "We realized losses," he adds.

The introduction of the new exchange-traded share class could make such distributions even more rare. Indeed, Vanguard says it's launching the exchange-traded shares to drive short-term traders out of its traditional index funds. Investors who frequently buy and sell regular mutual funds can drive up transaction costs, reducing the returns for all investors. If the new class reduces the amount of short-term money flowing in and out of the actual portfolios, it can also reduce the possibility the fund will realize any capital gains.

In fact, the new exchange-traded shares could help reduce the rather large amount of unrealized gains that has built up in some of Vanguard's index funds. For example, 38% of the Vanguard 500 Index fund's $105 billion in assets -- some $40 billion -- would be unrealized gains subject to taxation if the fund were to liquidate today.

But when exchange-traded shares are redeemed by large institutional investors, the redemptions can be made with actual securities rather than cash. By unloading the lowest-cost shares in this manner, the fund can, over time, reduce its unrealized gains.

Send your questions and comments to

deardagen@thestreet.com, and please include your full name.

Dear Dagen aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.