Comparing the Costs of Index Funds and ETFs

[Note: This post was updated in May 2014 when the ING Direct Streetwise Funds changed their name to the Tangerine Investment Funds.]

The growing popularity of index investing has a lot to do with the increasing number of ETFs available, and that’s largely a good thing. ETFs generally have lower management expense ratios (MERs) than index mutual funds in Canada, so they are usually the best choice for large portfolios, especially if you make infrequent lump-sum contributions.

But ETFs carry additional costs that are often ignored by beginning investors. Trading commissions are the most obvious: it typically costs $10 to buy or sell ETFs, while index mutual funds can be traded for free. (Some brokerages do offer a limited selection of commission-free ETFs, and a few independents offer trades for less than $10.)

Are index funds or ETFs right for you?

All of which is to say that as marvelous as ETFs are, they are often inferior to index mutual funds for investors with small accounts. My rough minimum for using ETFs is $50,000, but the actual cut-off varies a lot depending which specific ETFs or index funds you use, the commission charged by your brokerage, how many trades you make, and whether the brokerage charges an annual account fee.

To help you make this comparison yourself, I’ve built a spreadsheet you can download here. You can fill in the each of the yellow cells according to your individual circumstances and it will calculate the total annual cost of several different options. I have pre-programmed the spreadsheet with three versions Global Couch Potato as well as the Tangerine Balanced Portfolio, which has the same asset allocation. You can customize it any way you like, but be careful not to mess up the formulas.

If you’re an investor who focuses only on MERs, you’ll be surprised at some of the results. For example:

  • If you’re investing $50,000 in the Global Couch Potato and plan to make 12 ETFs trades annually at $9.95, the TD e-Series funds are a less expensive option.
  • If you plan to make quarterly ETF trades (16 per year) then even the RBC index funds are essentially the same cost for balances up to $30,000. This is why ETFs are often inappropriate if you’re building a balanced portfolio in a TFSA or RESP, since these accounts are unlikely to be larger than that.
  • For small accounts, many brokerages charge an administration fee. If you assume a $50 to $100 annual fee, then the Tangerine Investment Funds become appealing for accounts under $20,000 or so, despite their 1.07% MER. In many cases they are cheaper than the ETFs and the RBC index funds, and while it may be slightly more costly than the TD e-Series funds, it is far more convenient for new investors.

Download the spreadsheet and give it a try. Compare your own portfolio’s costs to the Global Couch Potato options, being sure to include all trading costs and account fees.

100 Responses to Comparing the Costs of Index Funds and ETFs

  1. Shishir February 11, 2013 at 4:04 pm #

    Hi Couch,

    I am fresh out of school, minimal knowledge of finance, recently started working, with small initial savings ( ~ 5k) and have just started looking into managing my money better. I will be saving up a good amount so I am looking to build up a portfolio. After looking over your website (great work!) and others I see that TD e-series funds are the way to go for me. I opened a TFSA with Waterhouse and have bought some e-series. (1-2 for now).

    What I am confused about is the ‘tax efficiency’ regarding ETFs vs. Index funds (IF). Why are ETFs said to be more tax efficient?

    From what I understand, it’s pretty easy to employ a ‘day trader’ approach to e-series, since there is no transaction cost. Buy low one day and sell high the other day. But I have to worry about capital gains correct? From what I understand, 50% of my gains will be taxed as per my tax bracket.

    The other way to “make money” is to wait for the dividends to be paid out, and either reinvest and buy into the fund some more, or take it out as cash. Correct? And since I have a TFSA, these dividends are not taxed.

    Please correct me and comment, thank you
    -Shishir

  2. Canadian Couch Potato February 11, 2013 at 4:32 pm #

    @Shishir: The ETF structure allows the fund provider to create and redeem units without actually selling stocks and bonds within the fund, so they tend to incur fewer capital gains taxes than mutual funds. But if you are investing in a TFSA, this is irrelevant. And if you are using e-Series mutual funds, your dividends will be reinvested automatically, too.

  3. Shishir February 11, 2013 at 7:00 pm #

    Thanks for the reply. So is the ‘day trading’ option feasible? I am just curious. I’m sure it’s been thought of before. I guess the index funds just aren’t that volatile so the hassle to ‘day trade’ to make a quick buck here and there must not be worth it?

  4. Canadian Couch Potato February 11, 2013 at 7:07 pm #

    @Shishir: You cannot day-trade mutual funds. First, their prices are set at the end of the trading day, so you do not even know the exact buy or sell price. Second, there are fees for redeeming most mutual funds less than 30-90 days after buying them.

  5. Shishir February 11, 2013 at 7:14 pm #

    Great, thanks for the information!

  6. Shishir February 11, 2013 at 7:40 pm #

    CCP – In your analysis of ETF vs IF, are MER and trade costs the only 2 variables? i.e. use IF until the breakeven point and then switch to ETF once your portfolio gets large enough. And once your portfolio is large enough, ETFs are the way to go because of the lower MER – is this the only factor? Is there any data to prove that ETFs perform better than index funds?

    Also – what do you feel about the ‘managed’ TD e series funds? They have > 1% MER and a minimum first time contribution of 2000$, so I was wondering if they were popular and if so, why.

  7. MB February 11, 2013 at 8:35 pm #

    XBB Assets Under Management $1,947,633,838
    VAB Net assets: $35.6 million
    This is a huge difference while both tracking similar indexes. Can you please explain why and if it is an important factor for decision making for choosing 1 of 2 ETFs?

    Thanks,
    MB

  8. Canadian Couch Potato February 12, 2013 at 8:33 am #

    @MB: A fund with a lot of assets under management is likely to have some economies of scale that allow it keep its tracking error lower, and it’s likely to be more frequently traded, so its quoted prices are likely to be a little fresher. That is one of the reasons I have not been in a hurry to replace XBB in my model portfolios.

  9. Mansbridge February 15, 2013 at 12:12 pm #

    Not sure if this has been covered yet, but now discount brokerages are offering free ETFs (only costs to sell). I assume this changes everything… if so, can someone explain the consequences?

  10. Canadian Couch Potato February 15, 2013 at 12:33 pm #

    @Mansbridge: It does change things if you happen to use one of the two brokerages that offer commission-free ETFs. But for now that represents a very small proportion of investors.

  11. Mansbridge February 15, 2013 at 12:57 pm #

    Indeed, I do :) I was just wondering if there were any implications… from what I see, e-series mutual funds are now obsolete. Am I missing something? I am thinking of selling off all my e-series funds and buying ETFs.

  12. Canadian Couch Potato February 15, 2013 at 1:05 pm #

    @Mansbrindge: As long as you are confident that the brokerage you’re switching to offers all the services you want. Personally I think the e-Series funds are highly underrated. They offer preauthorized contributions, automatic reinvestment of dividends, simple rebalancing, no bid-ask spreads and other conveniences. I wouldn’t give that up to save 10 basis points, but I appreciate that others might want to.

  13. Mansbridge February 15, 2013 at 1:31 pm #

    Thank you for your response. As a young investor, I think those basis points will add up over my investing career. The other issues you’ve listed are avoidable somewhat…

    Great information on this site, I’m going through the last few years of posts :)

  14. Shishir February 17, 2013 at 11:30 am #

    @Mansbrindge @Couch: Sorry if this is a silly question, but where is the 10 basis points savings coming from?

    Also, CCP – In your analysis of ETF vs IF, are MER and trade costs the only 2 variables? i.e. use IF until the breakeven point and then switch to ETF once your portfolio gets large enough. And once your portfolio is large enough, ETFs are the way to go because of the lower MER – is this the only factor? Is there any data to prove that ETFs perform better than index funds?

    Also – what do you feel about the ‘managed’ TD e series funds? They have > 1% MER and a minimum first time contribution of 2000$, so I was wondering if they were popular and if so, why.

  15. Canadian Couch Potato February 17, 2013 at 1:06 pm #

    @Shishir: The TD e-Series funds are about 10 basis points more expensive than the equivalent ETFs. In my opinion, the benefits of the e-Series funds (preauthorized contributions, no trading commissions, no bid-ask spreads, automatic dividend reinvestment) are worth that difference.

    In general, it makes sense to switch to ETFs when a portfolio gets larger, and if you want to add additional asset classes that are not available with index funds. Any performance difference between ETFs and index funds (assuming they track the same index) comes down to the difference in fees.

    The Managed e-Series are simply “funds of funds.” They hold four or more other e-Series funds to form a complete portfolio. If you’re interested in one of these, it makes more sense to simply buy the individual funds in the same portion and pay about one-third the cost.

  16. JW April 5, 2013 at 1:09 am #

    I just need some clarification on your spreadsheet. I may be dense here but in cell B4 do I enter the total amount I have in my portfolio, or the amount I want to invest per year?

    I believe it’s the latter, but if this is the case then the spreadsheet doesn’t take into account the point at which the size of my portfolio will favor ETFs over index funds, correct? I mean, if I contribute 10K/year with 12 trades at $29.95 each, index funds are more cost effective but after how many years do ETFs become the better option? How is that determined?

  17. Canadian Couch Potato April 5, 2013 at 10:32 am #

    @JW: The amount in cell B4 is the current size of your portfolio, not the amount you plan to invest each year. The goal of the spreadsheet is to estimate your annual investment costs in the current year. There’s no way to project costs into the future without introducing new variables such as the amount you plan to add each year and the rate of return, which complicates things greatly.

    The idea here is that you keep an eye on your current costs and only move from index mutual funds to ETFs when the difference in costs becomes significant.

  18. Kevin April 5, 2013 at 8:09 pm #

    @CCP – I appreciate all your efforts. I would like to ask however – in the various discussions regarding ETF’s vs Index Funds, I do not seem to see any commentary on the fact that the holding period of your investments should have a significant impact on this decision.

    If you hold your investments for the long-term, doesn’t the higher MER of the Index Fund easily cause the overall cost to surpass that of ETF’s (as long as you are smart about your ETF purchases and try not to pay $9.95 per trade 20 times per year). Each year you hold the ETF or Index Fund, the Index Fund’s higher MER slowly creeps up and should pass the trading commissions. I didn’t do a detailed calculation but I would assume wouldn’t take long…

    What are your thoughts?

  19. Canadian Couch Potato April 5, 2013 at 8:14 pm #

    @Kevin: I don’t think that’s the right way to think about it, because this is not a permanent decision. For many investors, it makes sense to start with index mutual funds and use them until your portfolio reaches the breakeven point. At that point you can switch to ETFs.

  20. John April 7, 2013 at 10:46 pm #

    Im lookng into moving from actively funds to index fund but i am having a hard time seeing the ultimate benefit with 1 of my current funds.

    I hold the RBC Canadian Dividend Fund, even after factoring in the MER it has beaten the index over the long term, are there reasons im not aware of to suggest switching to the RBC Canadian Index Fund?

  21. John April 7, 2013 at 10:51 pm #

    I should add also that my RBC Canadian Dividend Fund is series D, 1.21% MER

  22. Canadian Couch Potato April 8, 2013 at 8:08 am #

    @John: There will always be some actively managed funds that outperform the indexes. The fact that only one of your funds has done so is the exception that proves the rule.

    That said, the RBC Canadian Dividend Fund’s performance is unremarkable. It underperformed the iShares S&P/TSX Dow Jones Canada Select Dividend Index Fund (XDV) over the last three- and five-year periods. Dividend stocks in general have outperformed the broad market, but the manager of the RBC fund was simply in the right asset class at the right time and showed no skill in selecting individual stocks. In fact, he subtracted value compared with a simple index fund of dividend stocks.

  23. John April 9, 2013 at 12:43 am #

    Understood. I used Morningstars compare tool to compare both funds.

    Can you answer another question for me? When I look up the trailing returns for the RBC Canadian Dividend Sr D here http://quote.morningstar.ca/QuickTakes/fund/Performance/f_Perf.aspx?t=F0CAN0721H&region=CAN&culture=en-CA
    they are different than reported in Morningstars compare tool, what gives?

  24. MC August 25, 2013 at 12:05 pm #

    @CCP, such great info here, thanks!

    Maybe I missed it but didn’t see it stated conclusively:
    I am going to go full CCP strategy (kudos to you) for long term retirement savings. I love monthly contributions however if I have >$50k per asset class (i.e. basic model cdn, us, intl, bond), or even close to it due to long term plan, then the clearly advised direction is ETF’s over e-series.

    Can you confirm/comment on the above statement?

    For me I’m going thru the transition to CCP and if the choice is as clear as the above statement I know I’m saving time in all the new institutions I have to engage and maximizing my returns at same time.

    MC

  25. Canadian Couch Potato August 25, 2013 at 12:17 pm #

    @Matthew: With a six-figure portfolio ETFs are probably the better choice, but monthly contributions are not cost-effective with ETFs. Across four asset classes you would be making 48 trades annually. In general, if you’re paying $10 a trade you shouldn’t be making transactions smaller than $1,000 to $2,000: even that is a 1% to 0.5% cost. You can still make monthly contributions to your account, but it probably makes sense to keep your ETF trades to minimum: perhaps twice a year, rebalancing at the same time.

  26. Shannon September 22, 2013 at 7:23 pm #

    I have a question about the MER charges that are in the Excel sheet you provided. When do we pay those fees? I use Action Direct at RBC and my trade fees are $9.95 per trade and was thinking of buying some Vanguard ETFs. Can I purchse them using my Action Direct account or should I purchase them through Vanguard? Or is the cost of fees the same? Thanks.

  27. Canadian Couch Potato September 22, 2013 at 11:03 pm #

    @Shannon: Fund MERs are taken from the fund directly, so you do not pay them directly, though of course they will impact your returns. ETFs can only be purchased through a discount brokerage account like RBC Direct: they are not available directly from the ETF providers such as Vanguard.

  28. Shannon September 27, 2013 at 8:03 pm #

    CCP,

    Thanks for the clarification.

  29. Ryley September 28, 2013 at 4:58 pm #

    Regarding the comments made by MC, it seems like if you go with Questrade (free ETF buys), you can make your ETF purchases every month pretty easily. I don’t know much about Questrade, but the comments in http://canadiancouchpotato.com/2013/02/07/scary-when-theyre-down-scary-when-theyre-up/ were mostly along the lines of “they are very barebones but fine for just contributing to an RRSP”.

  30. satuk December 20, 2013 at 6:35 pm #

    Can you please explain what is the difference between TDB905 and TDB911 funds? Which one to go for? Thanks

  31. Canadian Couch Potato December 21, 2013 at 11:41 am #

    @satuk: TDB905 uses currency hedging, which is designed to remove the effect of fluctuations in the value of the Canadian dollar relative to the currencies of the underlying holdings (euros, sterling, yen, etc.). I tend to recommend using non-hedged funds, because I feel they add costs without providing a meaningful benefit.

  32. satuk December 21, 2013 at 5:20 pm #

    Thanks for the response @CCP.

  33. AH January 26, 2014 at 2:54 pm #

    @CCP, the info you provide on this site is really helpful. Thanks for taking the time.

    I’m about to have $150K transfered from one RRSP provider to my new SDRSP at TD. Looking at your model portfolios, it seems like I should strive for the Complete Couch Potato mix (all ETFs) given my portfolio size, and I could easily keep costs low by not trading frequently.

    Can I buy ETFs via the SDRSP without paying back the tax refunds from previous contributions? (I guess it’s the same question as to whether future lump sum contributions to an ETF will be tax deductible using my marginal tax rate the same way I was accustomed to with managed mutual funds in the old RRSP.)

    And if it’s okay to buy ETFs with the $150K, but I’m at TD, is there any advantage to including some of the portfolio in eSeries funds at all?

  34. Canadian Couch Potato January 26, 2014 at 3:49 pm #

    @AHL: Contributions to an RRSP are tax-deductible regardless of what you purchase—ETFs, mutual funds, etc. You can even leave the contribution in cash.

    Regarding combining e-Series mutual funds and ETFs, you can indeed consider combining them:
    http://canadiancouchpotato.com/2012/12/06/ask-the-spud-combining-e-series-funds-and-etfs/

  35. CS February 20, 2014 at 12:19 pm #

    I have a question please.

    I am currently with BMO Investorline and have the following accounts with them:

    1. Non registered AC – $210K
    2. RRSP – $202K
    3. Spouse’s RRSP – $180K
    4. LIRA – $22K
    5. RESP (2 Kids) – $44K
    6. TFSA – $33K
    7. Spouse’s TFSA – $32K

    In total amongst all accounts there is $100K in cash. So far I have been doing self directed everything. All stocks.

    Now, to diversify, I figured, I should look at the Canadian Couch Potato as well.

    What would be my best and most cost effective options? ETFs? Index Funds? TD eSeries?

    BMO chrages me $9.95 per trade (for ETFs and Indes as well).

    Should I maybe move the cash to another broker that will offer free trades on ETFs or Index?

    Would really appreciate some help.

    Thanks!

  36. Canadian Couch Potato February 20, 2014 at 12:28 pm #

    @CS: I don’t see any reason to open more brokerage accounts to save a few bucks on trading commissions: you could set up a well diversified portfolio with a relatively small number of ETFs at BMO, and the costs would be minimal. I think you will find the real challenge is managing a large portfolio across multiple accounts. I would say it is one of the most difficult challenges for DIY investors:
    http://canadiancouchpotato.com/2012/03/12/ask-the-spud-investing-with-multiple-accounts/
    http://canadiancouchpotato.com/2012/03/15/a-spreadsheet-to-manage-multiple-accounts/

  37. CS February 20, 2014 at 12:38 pm #

    Thanks for the quick response. I had not thought of managing all the accounts as one portfolio and was actually thinking of have a CCP plan in each separately…. Wow, this will get quite complicated now.

    As for Index vs ETF, why would you I chose ETFs over Index?

  38. Canadian Couch Potato February 20, 2014 at 12:44 pm #

    @CS: You cannot buy the TD e-Series index funds through BMO, and the other options are much more expensive than ETFs, especially with a portfolio as large as yours.

  39. CS February 20, 2014 at 2:05 pm #

    Thanks. I was wondering if maybe I should open an account at TD for free trades of eSeries and Index…

  40. Victor February 25, 2014 at 8:39 am #

    @CCP

    I understand you recommend index mutual funds for low portfolio sizes or frequent contributions due to the commission fees on trading ETFs.

    I’m planning on opening a Questrade account and making frequent small contributions to several ETFs. This is for a longer term investment so I am not planning on selling very soon/often or doing frequent rebalances.

    I chose questrade specifically because of the lack of account fees, and because buying ETFs is free, commission is paid only on the sale.

    So in this specific case, I don’t think I would be penalized in any way for investing in ETFs vs index funds, is this correct? Are there still reasons I don’t understand, to avoid ETFs in this scenario?

  41. Canadian Couch Potato February 25, 2014 at 8:51 am #

    @Victor: Commission-free ETFs certainly change the math, and they can make ETFs more appropriate for smaller portfolios. My concern is that you still need to make all your contributions manually, whereas you can set up automated monthly contributions with index mutual funds. Many inexperienced investors also find it more intimidating to make ETF trades, which is more complicated than mutual fund transactions. Finally, there are so many ETF choices that many investors are tempted to get away from the basics instead of focusing on sticking to a long-term plan. If you can overcome all these challenges, then commission-free ETFs are a excellent choice.

  42. LD March 18, 2014 at 2:07 pm #

    Even if this is a couple of years old, this is a great article!
    My question is similar to @Kevin’s comment from up above. Why do you assume 6 trades per year by default in the spreadsheet and in your examples? That seems high. If the person is long-term holder (see @Kevin’s comment) they are certainly not taking cash out or even rebalancing six times a year. They chose an index ETF (hopefully a broad index) and will stick with it… so are you assuming these six trades are where the person is buying more? If so, then the six purchases can easily be reduced to one or two per year to reduce commission cost. Like @Kevin said the savings of MER every year should make the math go heavily in ETFs favour over the long run.

    I guess what I’m saying is that I don’t understand why the discussion focuses on the total amount invested (your recommendation was ETF for large portfolios only)… it has everything to do with the frequency you buy and sell.

  43. Canadian Couch Potato March 18, 2014 at 2:30 pm #

    @LD: The six trades is for the whole portfolio, not per ETF. When this post was written the ETF version of the Global Couch Potato had three funds (now it has four), so that assumed just two trades per year in each fund. Assuming the investor is making new contributions and rebalancing once a year, that seems pretty conservative. And of course the whole point of the spreadsheet is to allow you to adjust the number as you see fit.

  44. Omar April 29, 2014 at 12:08 am #

    Great spreadsheet; didn’t even think how much the trading costs would affect me if my allocations were below $50,000! Excellent work…

    Quick question:

    Aim: to get broad-based Canadian market exposure
    Investment comparisons: TD Canadian Index Fund – e (MER = .33%) vs. XIC (.05%)

    # of trades/year: At the minimum 3-4 (I plan on regularly contributing either monthly or quarterly. I find this way keeps small chunks going from each pay cheque and is a more disciplined way for me… thoughts?)

    Question: After tweaking around with the # of trades and accounting for the difference in MERs, the TD e-series fund comes out ahead because of $0 costs (I’m a TD Waterhouse online account holder). Do you have any idea at what contribution level there would be a break-even? Conversely, should I just buy the TD e-series in my TFSA account till I reach the prescribed $50-80k limit, sell and the convert to XIC?

  45. Canadian Couch Potato April 29, 2014 at 8:21 am #

    @Omar: There are too many variables here for me to give you a hard and fast answer. The spreadsheet should allow you to compare the cost of the options you’re considering. But my first inclination is to suggest e-Series funds with automatic monthly contributions. That’s something you simply can’t get with ETFs, and it’s so important. If you already have a TD Direct account, then this is all that much easier to implement.

  46. Donna May 5, 2014 at 7:05 pm #

    Hi Couch, Any advice for a Senior (72) who wants to convert her RIFF from a actively managed mutual fund with an MER of 1.89% to the TD e-series index funds. Currently have $51000.00 in Scotia Selected Balanced Income Portfolio.

  47. Canadian Couch Potato May 6, 2014 at 8:51 am #

    @Donna: I can’t make a recommendation for your specific situation. Assuming you are happy with the asset mix in your current fund, that would be the place to start. It is 65% bonds, 18% Canadian equity and 17% foreign equity. An investor can mimic that same asset mix with e-Series funds. You should be aware that the e-Series funds are only available through TD Direct Investing, so you may have to open a new account.

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