ETFs or index mutual funds: which are best?

Because they trade like stocks, one advantage of ETFs over mutual funds is that you can use limit orders, stop orders and good-through orders for example, and often ETFs also have put and call options on them which adds trading flexibility. But index mutual funds have their advantages too.

ETFs_or_Index_Mutual_FundsIncome investors have reason to be concerned about equity market forecasts. Some of the elephants in the room include increasing trade tensions, instability in emerging markets, the withdrawal of stimulus programs by the world’s top central banks, rising interest rates and inflating US equity valuations. These, then, are some of the things you’ll need to brace yourself for in the months to come, because at a minimum they have the potential to make for some very turbulent markets.

To discuss one elephant a little further, the Bank of International Settlements (BIS) has likened the impact of central bank stimulus withdrawals on markets to a patient coming off strong medication. Markets and economies, after all, have grown dependent on the loose monetary policies that were adopted because of the financial crisis of the last decade.

As for the sell-off in emerging markets this year, instability could become prolonged if recessions start to set in as some economists fear.

Where in the world to invest?

Here at home, of course, we’re not immune to the many risks that may weigh on markets in the coming months. The drawn out process of the NAFTA-cum-USMCA talks has contributed to a pullback in the Canadian stock market since the summer. So, while US markets have moved up, causing equity valuations to increase, Canadian equities have become cheaper.

That’s one reason why we think you should be gradually adding to Canadian equities right now. You need exposure to the US, of course, but the better valuations on this side of the border support more aggressive buying in Canada right now.

One way to add Canadian exposure without wrecking a carefully constructed portfolio of Canadian stocks and trusts is simply to add either a Canadian exchanged-traded fund (ETF) or a Canadian index fund to the list. But which is better?

Index funds are created to track the performance of a certain index. But they can’t deliver the exact same return as the index because of their management expense ratios, or MERs. MERs on Canadian equity index funds can run as high as 1.14 per cent in the case of CIBC Canadian Index Fund. Compare that to the MER of 0.18 per cent on the iShares S&P/TSX 60 Index ETF (TSX—XIU), which is on our recommended funds list. Over the long term, the higher MER on index funds can greatly reduce your return.

However, there is one case where index funds will be more suitable for you as an investor. You see, every time you buy iShares you normally pay a stock-type commission. So if you plan to invest a certain amount of money on a regular basis, to avoid paying a commission each time you can use a no-load index fund.

For bumping up your exposure to the Canadian equity market in one fell swoop, we prefer these iShares to a Canadian index mutual fund, particularly the CIBC fund noted above. TD Canadian index funds, however, offer more competitive MERs, which are further reduced if you choose their e-versions, which are available only online. TD Canadian Index Fund-e (Fund code: TDB900 (NL)), for example, has an MER of just 0.33 per cent.

This is an edited version of an article that was originally published for subscribers in the October 5, 2018, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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