October 12, 2009, 5:00 am

ETFs VS Index Mutual Funds: The Ultimate Battle!

by: The Financial Blogger    Category: Investment, Market and Risk
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ETF VS Mutual FundsMy best friend, the author of Intelligent Speculator, and I were debating which of the ETFs and the Index Mutual Funds is better when you want to invest directly in the market. It’s kind of like playing football without a helmet (fixed income) to prevent injury. While I like ETFs a lot, there are specific situations where you are better off with an Index Mutual Funds. So, we both decided to write a post about ETF and Index Mutual Funds to see which one is best. (You can read the Top 10 reasons why ETF’s are superior to Mutual Funds by Intelligent Speculator.).

What? Are you kidding me? It’s impossible!?! Really? All right, let’s look at why you probably think ETFs are the best investment in the world:

The very first argument is the one that doesn’t lie: yield graph over the past 5 years comparing the TSX 60, the XIU (TSX 60 ETF) and the Altamira Canadian Index Fund (NBC814)

tsx-graph-5-years

As you can see, the Canadian market, TSX 60 (annualized yield of 9.40%), is obviously the one with the highest yield over 5 years. Without surprises, the XIU (9.25%) is better than the Altamira Canadian Index Fund (8.84%). In fact, the small yield difference will make a huge difference if you keep the same investment over the next 25 years (and you should 😉 ). All right, one point for the ETF fan.

ETFs’ endless options

Another great advantage of ETFs vs index mutual funds is the endless trading options you have. There is a ETF for just about everything! You want to trade an ETF following financials? Resources? They all exist! I am pretty sure you can find an ETF following apple producers! This is not counting leveraged ETFs allowing you to make 200% of the index (beware, it is more dangerous than it seems, seductive even!). And this is something you will never find with Index Mutual funds because they need more volume. Most of the time, index mutual funds concentrate on big marketplaces (TSX60, SP&P500, Nikkei, etc.). So if you are looking for specialization, you will be happy to know that ETFs fan wins another point.

BUT! Because there is always a “but”!

There are a few reasons why I think index mutual funds are better than ETFs. However, those reasons are not valid for all investors. It basically depends on your investing situation more than on the product!

If you are building your RRSP portfolio with a bi-weekly or monthly automatic contribution, you won’t be able to trade ETFs every time. It would cost you astronomical trading fees. Actually, one of the biggest advantages of the index mutual funds is that there is no transaction fee (always considering the Altamira index funds… I don’t know all of them!). Therefore, if you are trading with small amounts, what you save in management fees, you will eat it (and maybe more) in transaction fees (unless you open a Questrade account with low commission fees 😉 ).


How about leaving your automatic contribution in a money market fund and invest it once a year? You surely can do that but may miss a lot of investing opportunities throughout the year. I would rather follow the market month by month.

A lot of people wait until the end of the year to invest in the RRSPs. This is also tricky from a financial planning perspective. Why? Because these people usually count on their bonus or raise to invest. If they don’t get one, they skip their RRSP contribution or contract an RRSP loan (which is the equivalent of contributing monthly…. With interest charges added 😉 ).

One last thought on ETFs vs index mutual funds

Several investors see the ETF’s endless trading options as a great advantage. However, if you are not an experienced advisor, you might concentrate and take high risks for nothing. Based on the stats that 7 professional portfolio managers out of 10 don’t beat their reference market, how, as a simple investor, you would be able to select the right sectors and beat the market? Some people do it… albeit for only a while 😉

So let me know what you think and read Intelligent Speculator’s take on ETFs vs Index Mutual Funds.

Questrade Democratic Pricing - 1 cent per share, $4.95 min / $9.95 max

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Comments

[…] but to voice our arguments in writing on our blogs. So after reading this post, you can go on TheFinancialBlogger and read Mike’s arguments in favor of mutual funds. I’m still having trouble believing […]

Maybe you can tell me this … how do EFTs pay out? Mutual funds I can kind of understand: We all join into a pool of money and if the pool grows then we are entitled to our share and can take it by withdrawing.

But in an ETF, how do we get at the value inside the ETF? Do they post dividends every so often? If not then I totally don’t understand because when I buy an ETF I am just buying a share that will never pay out. My only hope would be to get someone else to buy it from me at a higher price.

[…] Financial Blogger presents ETFs VS Index Mutual Funds: The Ultimate Battle! posted at The Financial Blogger, saying, “Let’s look at why you probably think ETFs are the […]

by: The Financial Blogger | October 17th, 2009 (1:07 pm)

CR,
you won’t get the dividend from the stocks representing the index. But since the company issuing the ETF’s actually buy the stocks, the value of the ETF will increase according to the market. This is why you are able to sell it at a higher price if the market goes up.

I hope this helps!

[…] The Financial Blogger presents ETFs VS Index Mutual Funds: The Ultimate Battle! posted at The Financial Blogger. Let’s look at why you probably think ETFs are the best […]

[…] If you hold mutual funds targeting the Canadian index and they are in the last quartile for the past 3 years, maybe it’s time to get rid of them. In my opinion, there are a lot of mutual funds that should not exist. Most equity mutual funds should be replace by ETF’s or Index mutual funds (you can read more about this topic with ETF’s vs Mutual fund). […]

[…] Financial Blogger presents ETFs VS Index Mutual Funds: The Ultimate Battle! posted at The Financial Blogger, saying, “Let’s look at why you probably think ETFs are […]

[…] Financial Blogger presents ETFs VS Index Mutual Funds: The Ultimate Battle! posted at The Financial Blogger, saying, “Let’s look at why you probably think ETFs are the […]

“Several investors see the ETF’s endless trading options as a great advantage. However, if you are not an experienced advisor, you might concentrate and take high risks for nothing. Based on the stats that 7 professional portfolio managers out of 10 don’t beat their reference market, how, as a simple investor, you would be able to select the right sectors and beat the market?”
I could not say it better

Hey FP, thanks for the response of: “you won’t get the dividend from the stocks representing the index. But since the company issuing the ETF’s actually buy the stocks, the value of the ETF will increase according to the market. This is why you are able to sell it at a higher price if the market goes up.” but that is the source of my confusion.

If ETFs NEVER pay out a dividend then why are they worth anything? We both probably learned from MBA finance that the value of a stock is just the PV of the expected dividends … of which ETFs apparently have none???

Hey Customers Revenge,

First off, many ETF’s do pay dividends. You can usually find ETF’s that pay dividends or ones that automatically re-invest them (depending on your tax situation, you will prefer one or the other).

But if we take the case of an ETF that does not pay dividends… Actually, value of a stock is the PV of cash flows

That would also be equal to: PV of dividends + Current Value

It is similar to buying a stock of Google which does not pay dividends and probably will not for many many years. Is the stock worthless? No. But you do need to use a different way to value it.

For example, you could value it according to earnings, instead of dividends.

IS and others are right, many ETFs do pay dividends.
Mutual Funds lost more people more money in the last crash AFAIK. IMHO Mutual Funds were created to steal from people like CR, they make a lot of commissions for a lot of people which is why bank/finance people keep pushing them.

I am not in this industry (Finance) at all but I would not recommend Mutual Funds.
ETFs are far superior to Mutual Funds and they leave you more options and control than Mutual Funds.

The way CR describes Mutual Funds sounds like some kind of Ponzi scheme (not to say anything bad about CR) but to me this illustrates some of the dangers of Mutual Funds.

ETFs are traded like normal stocks because they are basically a portion of stock holdings the ETF holds. This means you can always monitor their status and guarantee you won’t have a loss after you have a gain (use Stop Limit orders to virtually make it impossible to lose, Mutual Funds can’t ever do that for you). You could wake up one month and find all of your money has been lost which is what has happened with many who invested into Mutual Funds especially during October 2008.

You get paid out by some with quarterly or even monthly (REIT ETFs) dividends, and you to really cash out, sell your ETF after the stock has appreciated well enough.

I think ETFs are more transparent and far more beneficial for all people (but use the real stock when you can afford it, the dividends from actual blue chip stocks are far higher).

Someone explain how ETFs reflect value? They are traded on the market. Therefore the value is the last bid. There is no true link between the market value of an ETF and the market or “true” value of the underlying stocks. There might be arbitrage opportunities because of that.

I know how mutual funds work. It is not a Ponzi scheme, it is just managed money. ETFs do not seem to me to be the same thing because the valuation of a mutual fund is just the market value of the holdings divided by the number of units. How to ETF valuations tie to the holdings?

Also, stocks without dividends are worthless to the average retail investor. You just hope they appreciate. The company is worth something, but the buyer has no control and no prospect of cash. Eventually the company must pay dividends to be worth something, so the valuation is the hope of dividends in the future.