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 Funds My 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)

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.

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Comments

by: Intelligent Speculator | Top 10 reasons ETF’s are superior to Mutual Funds | October 12th, 2009 (6:06 am)

[...] 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 [...]

by: Customers Revenge | October 15th, 2009 (10:51 am)

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.

by: Articles this Week from Personal Finance Blogs | Personal Investment Management and Financial Planning Blog Directory | October 16th, 2009 (1:57 am)

[...] 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!

by: Best of Money Carnival #21 | The Canadian Finance Blog | October 19th, 2009 (4:08 am)

[...] 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 [...]

by: The Financial Blogger » Blog Archive » 8 Reasons Why You Should Sell a Mutual Fund | October 19th, 2009 (4:38 am)

[...] 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). [...]

by: Carnival of Financial Planning | ZachStocks | October 23rd, 2009 (6:56 am)

[...] 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 [...]

by: Economy and your Finances Carnival Oct 25 2009 | October 25th, 2009 (3:08 am)

[...] 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: daddy paul | January 2nd, 2010 (8:10 pm)

“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

by: Customers Revenge | January 3rd, 2010 (5:50 pm)

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???

by: IS | January 3rd, 2010 (5:58 pm)

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.