In Investing, Money

Investing Series: What is the difference between an Exchange-Traded Fund (ETF) and a Mutual Fund (MF)?

This is a part of the Investing Series.

A common question that I had when I started investing years ago was what the difference between a mutual fund and an exchange-traded fund was.

QUICK & DIRTY ANSWER:

If you’re familiar with mutual funds and how they work, Exchange Traded Funds (ETFs) are basically the same thing.

The major difference lies in mostly in how and where you buy or sell it.

You can buy an ETF on the stock exchange like a stock, but you can only buy certain mutual funds at the banks that created those mutual funds.

If you want to know what index mutual funds and index-ETFs to buy for U.S. or Canada, scroll to the bottom of this post.

LONG & DRAWN OUT ANSWER:

I like to start with the basics instead of assuming everyone knows everything, so here goes.

Skip sections as you see fit.

WHAT IS A MUTUAL FUND?

Already wrote a post on this.

Read: What is a mutual fund?


WHAT IS AN EXCHANGE-TRADED FUND?

It’s the same idea as a mutual fund: people pooling their money together to buy stocks.

The difference is that while mutual funds are usually only offered by the banks themselves, ETFs are traded and readily available to anyone on the stock exchange.

This matters because since mutual funds are only offered and “professionally managed” via banks, you can only buy a TD Mutual Fund at TD Bank and only if you are a TD customer.

Likewise, you can only buy a ScotiaBank Mutual Fund at ScotiaBank and if you’re a ScotiaBank customer.

ETFs are different in that anyone can buy them because you can buy them on the stock exchange, which is open to one and to all, and theoretically speaking you can sell them when they start to go down in price, and buy them again when they’re on the upswing.

(However I would just suggest buying them and not trying to time the market or trade them often)

Take for instance Vanguard or iShares ETFs that are based in the U.S. — Canadians can buy them on the stock exchange, even though we don’t live in the U.S., we are still able to buy them in U.S. dollars (although Vanguard is now in CANADA!! Yay!! Vanguard CANADA!!).

Vanguard also issues mutual funds directly on their site, that are the exact copies of what they offer as ETFs as well.

Same stuff, but with a different way of buying into it.

SO WHY WOULD I BUY A MUTUAL FUND AND NOT AN ETF?

Taking index-tracking funds out of this particular answer, and looking at actively managed funds, you’re presumably buying expertise and experience.

Actively managed mutual funds run on the idea that you are buying into the expertise of the managers who have been hired by these big banks, and these bank managers secretly kind of look like this**:

whoozit-toy-bank-manager

Manhattan Toy

**Okay so while they don’t really look like this toy, I see their ‘expertise’ as such — all fun and games, in your face, and delivering flashy returns but when things go down south, they shrug and say “Ooops”, because it wasn’t their money in these funds.

They’re banking the sweet, sweet bonus that they earned that year from SELLING those funds.

It kind of goes like this:

So-and-So at Bank Whoozit has this-and-that degree in Whoo Finance, and she is such a dynamo, she can pick amazing stocks in this actively managed mutual fund and get you a return of 50% a year, guaranteed.

In contrast, if you went to a different bank, Bank Whizzit who claims to have THE BEST fund managers you can find, you’d find another So-and-So there, who claims to be able to get you a return of 51% a year!

You get the drift.


If you bought an ETF, you’re also buying into the same expertise, possibly with another person or company, and probably with someone who doesn’t work at your bank.

It just depends on what kind of expertise and whose expertise you trust more with your nest egg and how much you’re willing to pay for it.

WHAT ABOUT IF I JUST WANT TO INVEST IN INDEX FUNDS?

If you’re only investing in index funds, it basically works out to be the same thing whether you are with an index mutual fund at a bank, or an ETF that tracks an index on the stock exchange.

As I mentioned above, sometimes it’s exactly the same thing — it’s just how you want to buy it (with an account, or on the stock market).

I mean, if you’re already thinking of index funds rather than actively managed funds because in the very long-term it always outperforms actively managed mutual funds, it means you’re already on the right track.

Shanghai-China-Photograph-Maglev-Train-Tracks

Photograph I took of the Shanghai Maglev train station

So assuming you invest in these 4 categories for index funds:

  • Canada (or your country’s index fund; I put Canada because I’m Canadian)
  • U.S. (generally a standard country to invest in, as it drives a big part of the world economy)
  • International (I classify this as: “Not North America” 😛 ; includes Europe, Asia, Africa, Australia)
  • Bonds (your country’s bonds)

You can find these types of index funds at basically any bank (just look for the ones that say words like “this fund seeks to track the index of…“, and they’re available as ETFs as well.

ETFs may have lower MERs or fees than index funds at your bank*, but you shouldn’t neglect the fact that it will also cost you money to buy and sell ETFs, because they’re traded like stocks.

*This is very true with TD Canada Trust mutual funds, even with their their e-series mutual funds.

I should note that some banks may charge you a fee to buy and sell mutual funds (also called a “load fee”), but from my experience with mutual funds, generally they’re no-load at banks, and essentially free to buy and sell if you’re the bank customer.

The main difference between choosing index mutual funds or index-tracked ETFs comes in when you look at the FEES you pay which of course, hinges on how much you have in assets.

SO HOW MUCH DO I NEED IN ASSETS TO BUY ETFS OVER INDEX FUNDS?

Where it generally matters is if you have about $120,000 in assets or more, but this has changed with the entrance of Vanguard Canada.

Now you need maybe about $50,000 – $60,000 in assets for you to buy ETFs and gain lower MERs than index mutual funds.

canada-rolled-up-money-cash-bills

 

You can get a little bit of a deal by buying an index-tracking ETF instead of an index mutual fund at a bank.

You save slightly more money in terms of fees over the long-term, about $500 – $750/year if you’re willing to dive in to a slightly more complicated situation, and by that I mean:

  • you have to sign up for another account altogether, which also leads to more paperwork
  • you have to learn how to buy and sell an ETF on the brokerage system like Questrade Canada (which by the way, now lets you BUY them for free; Selling is another story.)
  • you have to know what you’re doing in when you go to re-balance your portfolio (buy/sell ETFs)
  • you can only rebalance about 3 times a year (assuming you buy 4 index funds) for these savings

The last point is especially important because if you touch your ETFs more than 3 times a year, either buying or selling those 4 index funds (which costs you money each time), you’ll lose out on any benefits in terms of fees, than if you just stayed at your bank with their index funds.

WHY THIS HAS CHANGED WITH THE ENTRY OF VANGUARD CANADA

However with the NEW entry of Vanguard Canada into the market for Canadians, their MERs are a lot lower than iShares or TD E-Series, think: 0.15% as an MER instead of 0.35%!

I have a post coming up on this next week in my Investing Series, and you save a significant amount of money even if you trade more often than 3 times a year with 4 ETFs.

WHAT ABOUT U.S.-BASED ETFS LIKE VANGUARD?

CAN I BUY THOSE IN CANADA?

Yes, you can.

In fact, the ETFs I am listing below from iShares, are U.S.-based.

There are two main points I want to bring up for this:

1. IF YOU BUY AND TRADE IN US DOLLARS, YOU’LL NEED US DOLLARS (and vice versa!)

If you buy and trade in U.S. dollars (this goes for buying stock, like Starbucks SBUX for instance, only trades in USD), you need to already hold USD in your account.

Otherwise, if you buy a USD stock or ETF, you will NOT have your CAD money convert automatically into USD to purchase the stock. They’ll let you buy it on margin (a.k.a. “credit”), and at the end of the month they usually ask for you to pay it back.

I really want to warn you to be careful about buying on margin because they WILL ask for the money at the end of the month to square up your account.

If you need to convert $CAD to $USD, they’ll charge you about 1% in currency exchange fees. It’s a bit of a headache.

That said, to avoid headaches, you can do what I do, and hold a U.S. dollar chequing account at a bank, and just link that up to your account.

Then you can just funnel in U.S. dollars into your brokerage account, and as they’re already converted, they’re ready to use.

I usually do a conversion of $CAD to $USD in my bank account (at TD who charges a fee for this) before I create a Pre-Authorized Debit (PAD) request in Questrade to take the $USD.

2. BE AWARE THAT U.S.-BASED ETFS HAVE AN APPLICABLE DIVIDEND TAX OF 15%

One thing I will point out for Canadian investors is that to be careful with ETFs that are based in the U.S. such as iShares or Vanguard, because any dividends you may be eligible to receive, will be subject to a 15% tax withholding by the U.S. government if they are not held in retirement savings plans such as an RRSP or a 401K.

This 15% tax is taken out before it reaches your account, even if you buy the Canadian version of this ETF (it’s just the U.S. ETF held in a Canadian shell).


You can recover this 15% tax as a partial credit if you’re conscientious and keen on keeping track of all this, but you have to fill out some tax forms to do so, which may not be your cup of tea.

That said, American-based ETFs are generally cheaper so it may be worth your time and trouble.

I have a post coming up in this Investing Series on dividends as an investment strategy that you might want to wait for, to learn all the Canadian tax implications of buying U.S.-based ETFs.

WHAT IS AVAILABLE FOR ME TO INVEST IN CANADA OR THE U.S. FOR INDEX MUTUAL FUNDS OR ETFs?

DISCLAIMER: The following is by no means a comprehensive, or detailed list of all the Index Funds or ETFs available in Canada or the U.S..

When reading the lists below, you are still responsible for doing your own research and asking a third-party professional to assess your situation if you need help. 

flag-usa-canada

WHAT ARE SOME INDEX MUTUAL FUNDS IN CANADA?

From my experience, TD Canada Trust E-Series is the best and cheapest set of index mutual funds you can purchase. No load fees (you don’t get charged to buy or sell them), and they have the lowest MERs I’ve found (in the e-Series only).

It is also the easiest way to deal with index fund investing in Canada, but not the cheapest depending on how much you have to invest.

Here’s the list of TD Canada Trust E-Series Mutual Funds.

If you’re already a customer (either with TD Canada Trust or TD Waterhouse*), you can buy these index fund names:

Read: How to invest with TD Canada Trust E-Series Mutual Funds.

*You do NOT need to open another account with TD Waterhouse to buy TD Canada Trust E-Series funds.

**Currency-neutral means it takes into account currency exchange fluctuations and takes into account the risk of that currency losing its value (also known as the practice of “hedging”). Generally speaking, the NON-Currency Neutral Mutual Funds are more volatile, and currency-neutral are less volatile.

***When it says ($US) like that, it means it’s held in U.S. dollars. Again, the fund hinges on how the USD fares.

WHAT ARE SOME INDEX EXCHANGE-TRADED FUNDS (ETFs) IN CANADA?

You can sign up with Questrade, and buy iShares (offered by BlackRock) or Vanguard Canada index mutual funds on the Toronto Stock Exchange (TSE), and are basically the exact mirror of U.S. ETFs.

Remember, with the new policy that Questrade has going into effect for February 1st, you can buy ETFs FOR FREE. No commissions on the purchase, but if you decide to sell them, you will have to pay something, so try and save your $50 rebate in free Questrade trades to put them to good use.

This makes it even juicier of a purchase.

These are just some of the U.S.-based ETFs available in Canada to purchase.

iShares

They are pretty much the same as the U.S. ETFs offered by iShares (BlackRock) listed below, they just have a different ticker symbol and trade on the TSE.

Vanguard Canada

New entrant into the Canadian Index ETF market, and they’re cheaper.

Post coming up next week on the comparison.

  • BONDS = VAB — Vanguard Canadian Aggregate Bond Index ETF
  • BONDS = VSB – Vanguard Short-Term Bond Index ETF
  • CANADA = VCE — Vanguard MSCI Canada Index ETF
  • U.S. = VSP — Vanguard S&P 500 (CAD-hedged) ETF
  • U.S. = VFV Vanguard S&P 500 Index ETF
  • INTERNATIONAL = VEF — Vanguard MSCI EAFE ETF (CAD-hedged)

WHERE YOU CAN BUY STOCKS OR ETFS IN CANADA – QUESTRADE

If you use my referral ID with Questrade [ o0soehds ], you can get up to $50 in free trades, but you can buy those ETFs for free as they are now commission-free. If you sell them afterwards or change your purchase order, you will have to pay a fee.

You can enter this code [ o0soehds ] when you open your new account and after pressing “Enter”, it should immediately display what the deal is ($50 in free trades).

You can also hold RRSP and TFSA accounts in Questrade as well, and trade stocks or more ETFs in them.

Seeing the “.TO” at the end of Ticker Symbols:

Stocks or ETFs on the Toronto Stock Exchange, may have a .TO at the end of their ticker symbol depending on who you use to trade with, so don’t be surprised if you can’t find “XBB” on Questrade, but you find “XBB.TO“.

This is to differentiate between the same company ticker symbol being traded on different stock exchanges.

Questrade for instance, uses .TO in its ticker symbols.

Photograph-Travel-NYC-Central-Park-New-York-City-USA

Photograph I took of NYC

WHAT ARE SOME INDEX MUTUAL FUNDS IN THE USA?

What I will say is I’d really suggest looking outside your bank towards Vanguard or iShares, because they’re more than reasonably priced especially if you’re based in the U.S. with such a wide range of cheap index funds to purchase from.

Otherwise, talk to your bank, or poke around the internet to find some U.S. bloggers who might be able to help you specifically.

I really didn’t like the banks in the U.S., to be honest. They were throwing all these books and pamphlets at me of ALL THE FUNDS that they re-sell under the bank name, and if they thought I was going to sift through 300 funds in a book to pick a few that I wanted, they were crazy.

They didn’t have them available online to look at either. You NEEDED their books.

But I guess that was the point.

They wanted to confuse me with all this nasty paperwork so that I would tell them: Do whatever you want with my money! Just make it grow!

Then they’d erode my money over the years like a bunch of locusts…….

So if your bank offers mutual funds, they are sure to offer index funds as well but they may not be the cheapest in all of the U.S. in terms of MERs.

WHAT ARE SOME INDEX EXCHANGE-TRADED FUNDS IN USA?

Here are some index fund ETFs you can look at for the U.S. It is DEAD EASY to set up an account with them and ABSOLUTELY worth it.

All of their funds are listed online so you can peruse them on your own time.

Vanguard

iShares

I think that does it.

I hope I’ve given a painless (as possible) overview of mutual funds, ETFs and the differences and benefits between the two, taking into account some Canadian and American perspectives.

If anyone sees any discrepancy or problem with the above information PLEASE TELL ME IMMEDIATELY!

SUMMARY

  • The difference between mutual funds and ETFs are how they are sold and bought, but they’re essentially the same concept
  • Mutual Funds are funds you can buy either directly with the institution or the bank
  • Many bank mutual funds are only offered at your bank, and only if you’re their customer, but may contain the same stocks as other banks who offer their flavour of mutual funds as well
  • ETFs can be purchased by pretty much anyone with a brokerage (stock market) account
  • ETFs (true in Canada) are generally cheaper in terms of MERs than mutual funds at a bank, but may cost you more in terms of how much it costs to buy and sell them (Questrade charges no commissions on buying ETFs; only on selling them)
  • Mutual Funds (with no load fees), don’t cost you anything, but almost definitely take a higher MER cut

Share Tweet Pin It +1

Sherry of Save. Spend. Splurge.

I got out of $60,000 of debt in 18 months using TheBudgetingTool.com. Since then, I have worked 50% of my career (taking 1-2 year breaks), and quadrupled my income within 2 years of graduating, going from $65K to $260K (savings rate = 85%). I could retire today if I wanted, but love my work-life balance as a freelancing consultant in STEM (Science, Technology, Engineering, Math). I also post daily on Instagram @saverspender.

You may also like

Ask me Anything! – Responses Part Two

Posted on February 26, 2015

Previous PostSelective Minimalism: What is remaining in my wardrobe that fits into two suitcases!
Next PostWomen: The new rise of wealth and spending in a global marketplace

No Comments

Leave a Reply