Q: Under what specific circumstances would it be better to hold a US-listed ETF if there is a Canadian equivalent? For example, when it is preferable to use the Vanguard Total Stock Market (VTI) rather than the Vanguard U.S. Total Market (VUN)? — R. F.
Until late 2012, there really were no great options for Canadian ETFs that held US and international equities. If you wanted a low-cost, cap-weighted index fund that did not use currency hedging, you were out of luck. That’s why my Complete Couch Potato model portfolio currently uses a pair of US-listed ETFs for its foreign equity components.
But the case for using US-listed ETFs is not nearly as compelling as it used to be. Since April, iShares and Vanguard have launched inexpensive Canadian ETFs covering the broad US and international markets without currency hedging. For example, the Vanguard U.S. Total Market (VUN), launched in August, is virtually identical to the Vanguard Total Stock Market (VTI)—indeed, VUN simply holds units of VTI.
There are three important differences between these ETFs, however:
- VUN has a higher management fee: 0.15% compared with just 0.05% for VTI
- VTI trades in US dollars, which may result in investors incurring significant currency conversion costs
- VTI is exempt from the 15% US withholding taxes on dividends if it is held in an RRSP
VUN has the edge in taxable accounts and TFSAs
In my opinion, VUN should be the default choice if you’re holding US equities in a non-registered account or a TFSA. In these two account types, neither fund has any tax advantage: both ETFs are subject to the withholding tax on dividends. In a non-registered account, the tax is recoverable by claiming the foreign tax credit, while in a TFSA it cannot be recovered.
That means the only issues to consider in a taxable account or TFSA are the differences in management fees and the cost of converting currency. And in most cases, the foreign exchange costs will have a larger impact.
VUN’s additional management fee of 0.10% (the full MER will likely be a couple of basis points higher) amounts to just $10 on every $10,000 invested. That’s peanuts. If the alternative is paying your brokerage’s normal currency conversion rates (which may be upwards of 1.5%, or $150 on $10,000), then VUN is a no-brainer. Even if you’re comfortable doing Norbert’s gambit, remember this typically involves two $10 commissions and a small spread, so do the math and ask yourself whether it’s really worth it. It probably isn’t unless the transaction is very large.
VTI makes more sense in an RRSP
If you’re holding US equities in an RRSP, then it’s worth taking a closer look at VTI. With the yield on US stocks now at about 2%, the withholding tax represents an additional drag of about 0.30% for VUN. So now the total cost difference—including both the higher MER and the withholding tax—is more like 0.40%.
At that point it’s worth at least considering using Norbert’s gambit to convert your loonies to US dollars in order to purchase VTI. Again, however, the size of the transaction is important. Norbert’s gambit is usually not efficient unless you’re exchanging five-figure sums, so if you’re contributing a few thousand dollars a year to US equities, VUN is likely to be the less expensive option even in an RRSP.
And if you are willing to pay a little extra for the convenience of making all your trades in Canadian dollars (and there’s nothing wrong with that), VUN is likely the most appropriate choice in any type of account.
@Henry: Thanks for the comment. I do revisit this idea in my book, although everything in this old blog is still true. I would not recommend using US-listed ETFs in TFSAs or non-registered accounts. In theory they have some advantages in RRSPs, but only if you are able to convert CAD to USD at low cost. There is absolutely nothing wrong with using a fund like VEQT in an RESP.
Thanks, Dan!
What is the name of your book? Is it “Reboot Your Portfolio: 9 Steps to Successful Investing with ETFs”?
The difficulty I have is that I already have some USD in my account, and I am not sure if it makes sense to convert them back to CAD so that I can invest them in an unregistered account, as it will cost conversion fees.
If I want to buy some US ETFs in my RRSP account, what should I consider? I saw the post mentioned VTI. I trust there are others I should consider such as the ones hold full market except US market and the onces hold CA market? Thanks!
@Henry: Yes, that’s the right book. :) VTI covers US stocks and VXUS covers the world ex-US. Vanguard’s VT includes both, so that is a simple one-fund solution for a global equity portfolio denominated in USD.
Wow, what excellent timing. VT is exactly what I’m looking for as I’ve just unexpectedly found myself with USD in my brokerage account.
Thanks Dan and Henry!
Thank you so much, Dan!
I just bought your book. It is very helpful! I guess I may have to spend some time with bookkeeping.
One last question, if I want to balance the risk by adding some US-listed Bonds EFT, what are the choices I should consider?
@Henry: Thanks for picking up the book. I generally do not recommend using US-listed bond ETFs, as this introduces currency risk to the fixed income side of the portfolio, whch is likely to increase volatility rather than decreasing it (see pages 81-82).
Thanks, Dan! That makes sense. I guess I need to read your book from cover to cover.