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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