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.
Just curious. If there is no NG required, i.e. I have USD to invest and can take the funds out in USD, is VUN a better choice than VTI based on forced dividend conversions to CAD alone? Does that compensate for the higher MER of VUN?
@Shane: If you have USD already, then VTI is almost always a better choice. The forced conversion of dividends (which only applies at brokerages that do not allow USD cash in registered accounts) is a trivial issue. Even if you assume the spread is 1.5% and the yield is 2%, that’s an overall cost of 0.0003% annually, or $30 on a $100,000 investment.
Really enjoy your articles, thank you. Quick question on this topic – I’m considering buying Vanguard S&P 500 Index (VFV) in my RRSP as well as in my kids’ RESP. Are there tax consequences of doing so? I get a bit confused on the rules. Any clarity would be greatly appreciated! Thanks again
@Rick: Glad to help. The withholding tax consequences are the same for VFV as they are for VUN: in an RRSP or RESP there is an extra tax drag of about 0.30%. But in an RESP the amount is likely to be very small and not worth worrying about. In an RRSP you face the choice outlined in this post: technically a US-listed ETF would be cheaper if you are able to convert the currency at low cost, but if you decide that’s not worth the hassle, using VFV or VUN is still a good choice.
At Questrade I’ve found that it can be cost-effective to do NG for smaller amounts like $2000 since you should only pay one $5 commission plus the spread if you use DLR. That is the cheapest currency conversion I’ve done.
For those who like making monthly contributions and then switching later, a new option would be to buy VUN every month (no cost) and then switch a larger amount to VTI later (2 $5 commissions + spreads). That should come out ahead as long as you’re holding for 10 years. Even outside Questrade you can convert a large amount for a fee of 0.5% – 0.8%.
However like Shane I’ve started taking income from the US and just investing that to avoid two conversions.
If one already has a fair bit of VTI in their portfolio, back from before VUN existed, I assume it’s fine to keep it (esp if it’s in an RRSP); but if in the future as the portfolio grows there becomes a need for additional U.S. equity outside the RRSP, would there be any reason not to hold some of each? For instance, some VTI in the RRSP and some VUN in a TFSA or non-registered account? And in such a case, which would be better to add to / sell off when rebalancing?
@Alex: If you already own VTI in an RRSP I can’t think of any good reason to sell it and switch. And there’s nothing wrong with using VTI in the RRSP and VUN in other account types.
Thanks for the analysis, Dan. I’ve been following the developments on this front for a while but can’t quite bring myself to change from VTI, which I’ve held since I began a DIYer in 2008. I hold VTI only in my RSP. While I’m not crazy about the extra costs I incur for buying/selling VTI over VUN, holding USD-denominated securities is yet another form of diversification that could offer benefits over the long run. The recent depreciation of the Canadian dollar against the greenback has helped boost up my VTI position nicely, although who knows where currencies will be next month or year, let alone in 2020. But there’s something satisfying about holding more than one currency in a portfolio.
One other issue that comes to mind is the rule about Canadian investors with large sums in USD-denominated securities. I can’t remember the specifics, but I remember thinking that my VTI position could start to cause me some grief in the late 2020s.
@Doug: As I mentioned in response to Alex, there is no reason to sell a US-listed you already own, especially in an RRSP. My suggestions in the post assume you’re making the decision for the first time. Concerns about US estate taxes should trouble you only if your worldwide assets are valued at more than US$5.25 million. :)
One important clarification: you mention that US-denominated securities provide extra diversification, but this is not true if you are comparing them to Canadian-listed ETFs without currency hedging. VTI and VUN have exactly the same exposure to currency risk, because the underling securities are the same regardless of the currency in which they trade.
For new contributions that is less than $5k going into the RRSP, would you suggest buying the Canadian version of the ETF and then switching when the amount grows large enough?
@Mk: A few people have mentioned that option, and it’s fine if you’re inclined to do that. But my guess is you’ll find the savings to be extremely small compared with the hassle involved.
Very interesting post.
I’d love to see an equivalent analysis for non-North American ETFs such as VEA/VXUS/VWO and their Canadian-listed equivalents.
Just to follow up, if a person has an existing position in VTI in his/her RRSP, and that individual typically has annual RRSP contributions of about $5,000 or less, what would you say is the best strategy with the new contributions every year — add it into their existing VTI or buy VUN? Or irrelevant?
@Paul G: The principles are exactly the same for international equities. The big difference is that you can get developed and emerging markets in a single trade with VXUS, but you would have to use two Canadian-listed ETFs to get the same exposure.
Thanks for the post. I was wondering recently about something like this for my taxable accounts, and arrived at the same conclusion for the US market. I can’t arrive at any meaningful conclusion on the international side, though, maybe because I can’t find any really good Canadian ETFs looking at the international market.
For VXUS, would you replace it would XEC and XEF, for a combined fee of 0.65%, compared to 0.16% for VXUS? That’s a big difference.
If so, would holding VXUS be better if the currency exchange could be performed for less than 0.49%? Are there better Canadian ETFs to use?
Hi Dan, thanks for the easy-to-follow guidance.
As a sanity check, though: could this be one of those cases where some of us have our fee-phobia triggered and obsessively optimize something with low impact, but trigger unintended consequences with a higher negative impact? Are there asset location “traps” inherent in deciding to shelter US equities in your RRSP to take advantage of VTI?
I am under the impression that anyone who holds US assets will be subject to death taxes if total wealth (not just the US assets) is over $1,000,000, down from $5,000,000. That could eventually, maybe even currently, include a lot of unsuspecting victims . Is this correct and if so how would the IRS know the total asset value?
@Tyler: If you are combining XEC and XEF you don’t simply add the MERs to get the total cost. To approximate the mix of developed and emerging markets in VXUS you might use two-thirds XEF and one-third XEC, which would result in a weighted MER of calculated as follows: (0.67 × 0.30%) + (0.33 × 0.35%) = 0.32%
@Neil: I think the issue is that MERs are extremely easy to compare, so many investors are inclined to dwell on them. The cost of currency exchange is almost completely hidden, and I have seem many investors simply by US-listed ETFs with Canadian dollars and remain blissfully unaware that a single transaction wiped out several years of MER savings. Withholding taxes are also invisible in RRSP: many investors will have no idea they are paying them. It’s important (but difficult) to consider the whole picture.
@Al: Let me be clear I am not a tax specialist, but this document explains the 2013 changes to US estate tax laws:
http://www.pwc.com/en_CA/ca/estate-tax-update/publications/pwc-2009-04-13-us-tax-exposure-canadians-2013-02-19-en.pdf
Thanks Dan. Hopefully all couch potatoes will one day have to plan accordingly!
CCP, do you mind if I ask a kind of related, kind of unrelated question about what to hold in taxable accounts?
Soon I will be above what I can stash in registered accounts. In order to maintain my current allocation of fixed income (i.e. bonds), I’ll need to start putting something in my non-registered account. You (and many other people) have talked about why it’s a bad idea to hold something like XBB or VAB (with their premium bonds) in a taxable account. I did find a post of yours where you talked about a new strip bond ETF (BXF) which is better suited for a taxable account than a normal bond ETF. Under what circumstances would you recommend BXF for example, rather than a GIC? 1 year GICs are currently have a bit better return than BXF currently, so would it only be for the liquidity?
Or is there a third choice that might be appropriate? Thanks.
@Tyler: Yes, the main difference between the strip bond ETF and GICs is liquidity. If you want to rebalance a portfolio and all the fixed income is in GICs, it’s hard to do.
Make sure you understand how a strip bond ETF works before your go that route. The fund’s current yield to maturity is about 1.8%, which is quite a bit higher than most 1-year GICs. Remember, too, that GIC returns are known in advance, but a strip bond’s returns will vary with changes in interest rates. If you like the stability and liquidity isn’t a concern, GICs are certainly simpler and more predictable.
Great! Thanks so much for your feedback! Currently, I think I can get a 1-year rate of 1.9% from a GIC (though I have not confirmed that with a phone call). So I will have to think about how if that’s worth losing giving up the liquidity.
Thanks again.
Dan, I’d been struggling with this question too.
Your answer was really helpful. Thank you!
Does your VTI to VUN comparison work for comparing when to use US-listed versus Canadian-listed ETFs in general?
Dan, would you ever recommend holding only VT as the equity portion of a portfolio, with XBB/VAB as the bond – just two-fund portfolio for the long run (30 years)?
Outstanding article Dan.
I’m with Alex above.
I have VTI in my RRSP and over time (if and when the RRSP contribution room is maxed out) I will add VUN non-registered or put VUN in my TFSA to keep my U.S. equity allocation where I want it.
I would also like to read a similar post about international equities (VXUS) and Canadian ETFs.
Mark
@Kevin and Mark: I just used VTI/VUN as an example here, but the same principles apply to international equities. The international portion of the withholding taxes are always lost in all account types, whether you use a US-listed ETF such as VXUS or a Canadian “wrap” like XEF or XEC. So only the US portion of the withholding taxes is treated differently, and those differences are the same as they are for VTI and VUN.
@Be’en: In theory I wouldn’t object to holding only VT for equities: you could certainly do a lot worse. But I would consider the currency risk: if your portfolio is heavily weighted to equities you would have a huge amount in foreign currency. It’s less of an issue if you hold only 20% or 30% equities and the rest in Canadian fixed income. I also think you give up some rebalancing and tax-loss harvesting opportunities when you use a single fund for your entire equity holding.
This may be of interest:
https://canadiancouchpotato.com/2012/05/22/ask-the-spud-does-home-bias-ever-make-sense/
Thanks Dan.
I figured the same logic would apply, just curious to see is spelled-out; different Canadian ETF products that could do the same work as VXUS in a Canadian non-registered account or TFSA.
Your article also reinforces another point for investors, fill up the RRSP or registered accounts in general first.
Now the next step, everyone email vanguard and ask for a canadian domiciled unhedged version of VXUS ! Its the last piece of the puzzle missing for canadian investor.
Thanks for the Article Dan.
My understanding is that VUN is a better option in a RRSP only if you’re trading in the 5-figure range.
So, in a RRSP that currently holds VTI, would you recommend keeping VTI but making new contributions ( a few thousands $ a year) to VUN?
Marcello
@Dan: Whenever the discussion comes up about what to keep in which account, I always get torn between what you discussed in this post, and the estimated return of equities versus bonds. Can you please let me know what you think?
If the estimated return of bonds is 3% and the estimated return of equities is much higher at 6.5%, then wouldn’t it make sense to keep the bonds in the RRSP and most the equities in the TFSA, since over time the TFSA should grow more than the RSP, instead of the other way around. Then, come retirement time you are going to be paying tax on the withdrawals from your RRSP but not the TFSA. Now, if the TFSA was quite a bit larger than the RSP due to that additional growth, the percentage of retirement withdrawal from TFSA would higher than from the RSP account, and therefore you would be paying less tax.
Does this make sense to anyone else out there?
I know this isn’t totally accurate, but you can even use an example related to this post:
$10,000 in a TFSA-VUN estimate return (6.5 – 0.3) = %6.2
After 30 years = $60,776.47 – Tax (zero) = $60,776.47
Verus
$10,000 in a RRSP-VTI estimate return = %6.5
After 30 years = $66143.66 – Tax (~20%) = $52,914.93
I am wondering if the withholding tax on Canadian wrap ETF like VUN is 30% instead of 15%, because the regular US withholding tax is 30% unless you sign W-8BEN form with your broker to lower it to 15%. Does US wrap ETF provider have the same ability to reduce it to 15%? or they get hit by the 30% rate and pass the bill to their clients?
@Que: In general I think you’re absolutely right: it makes sense to keep the slower-growing investments in the RRSP. In practice, however, this isn’t a critical decision now because TFSAs are so small: as of 2014 the maximum contribution room is $31,000, whereas many investors have several hundred thousand in their RRSPs. So don;t have full freedom to place everything in the optimal account.
The more important decision is whether to contribute to an RRSP or a TFSA in the first place (assuming you’re not maxing out both). That decision should not consider asset classes at all: if you earn a high income you should probably prioritize RRSPs, and you can keep both bonds and equities there. Low-income earners can do the opposite, prioritizing TFSAs and filling them with both bonds and equities.
@Francis: The US withholding tax paid by the ETF provider is 15%. You can actually see the amount of foreign tax paid in the ETF literature, for example (scroll to the bottom):
http://ca.ishares.com/product_info/fund/distributions/XSP.htm
Divide the foreign tax paid by the foreign income and you’ll see it’s very close to 15%.
@Dan: Thanks! Just to confirm, does VXUS or VNQI have any difference in a RRSP versus TFSA in terms of withholding taxes? If the answer is no, and since you agree with my last post, is the best place to keep international funds that do not include the US like VXUS and VNQI should be ideally in a TFSA?
@Que: Yes, there is a difference in the withholding tax treatment: in TFSA, you will pay two levels of withholding tax with VXUS (US and international), while in an RRSP you will pay only the international portion. See fund type C in this post:
https://canadiancouchpotato.com/2012/09/17/foreign-withholding-tax-explained/
@Dan: I am confused, VXUS does not contain any US stock, are you saying that they still withhold 15% just because Vanguard the managing company of this fund, is in the US?
@Que: Yes, VXUS is a US-domiciled security even though its underlying holdings are foreign stocks. It is therefore subject to US withholding taxes.
Has anyone looked into the withholding taxes of TD e series funds eg tdb91 1? Would there be less taxes as the foreign equity is directly held by a Canadian fund? opposed to a wrap fund from vanguard or I shares. What would the difference amount to?
So _IF_ there was a Canadian version of VXUS, (unhedged, canadian domiciled) as suggested above by LawrenceW, then this would eliminate one level of withholding tax in a TFSA or non-registered account (the 15% US portion)? Is this correct?
I hold some VTI and VUN but I still prefer to invest in US ETFs using US funds. First of all VTI, has a higher yield than VUN (i.e. This makes no sense to me). Secondly, with the Canadian dollar declining it makes sense to put some cash into US funds. Once you’ve converted to US funds you can buy VTI or individual US stocks. But more importantly, you can sell some stock or rebalance and still keep the proceeds in US currency. That way you lock in any gains you’ve made by the decline in the Loonie.
@Phil: Great question about withholding taxes on Canadian mutual funds that hold international stocks directly (which is rare with ETFs). Justin discusses it here.
@John Paul: No, a Canadian version of VXUS would still be subject to two levels of withholding taxes. It would fall into category E as described here:
https://canadiancouchpotato.com/2012/09/17/foreign-withholding-tax-explained/
@Dennis E: It’s important to make these decisions based on accurate info. VUN was launched in August and has paid only one distribution, so any reporting of it yield is meaningless. It can be expected to pay the same yield as VTI, minus the 15% withholding tax. Also, the currency risk in VTI and VUN is identical: although VUN trades in Canadian dollars, a rising US dollar will have the same positive effect as it would in VTI.
Dan, valid comments but historically is it not more profitable to buy SPY (USD) as compared to XSP (about 1.5% annually)? Shouldn’t that be reason enough to purchase in USD? Appreciate your comments.
@dave: The difference is XSP uses currency hedging, while VUN does not. It’s the hedging, not the trading currency of the ETF, that causes the dramatic difference in returns.
Dan, I’m not sure I’m convinced that VUN will yield the same return as VTI. You only have to look at VRE, which I was dumb enough to buy. VRE yeilds a lousy return … much less than the underlying REITs which it holds and this ETF has been operating for a while now. Looking back either ZRE or XRE would have been a much better choice. So, I wouldn’t pile onto the VUN bandwagon until it’s substantially larger and has a better track record of paying the yield that it’s supposed to.
@Dennis: VUN simply holds shares of VTI and nothing else, so it will collect the exact same amount in dividends, though its yield will be reduced by withholding taxes (potentially recoverable) and the slightly higher MER.
As for VRE, I don’t understand why the fund would yield less than the weighted yield of its underlying holdings, except for the small drag caused by its fee. ETFs are trusts, which means they are obliged to pass along their investment income to unitholders so it retains its character as interest, dividends, etc. They don’t have the option to simply keep it for themselves.
@Dennis: To follow up, I have sent a request to Vanguard for a comment on the distributions and will let you know what I turn up. In the meantime, you may find this post helpful: it describes the different strategies used by VRE, ZRE and XRE. Their relative performance is likely to be determined by the performance of their largest holdings, namely RioCan, H&R and Brookfield. In any given year their performance can vary widely, but it’s not predictable in advance:
https://canadiancouchpotato.com/2013/02/11/under-the-hood-vanguard-ftse-canadian-capped-reit-vre/
I have also recently compared VRE (which I hold) to ZRE and XRE and concur with Dennis. The yield on VRE is 2.8% compared to 5% for the other two. In fairness, however, if you look at the value of the fund itself, VRE is down -5.87% on the year compared to -12% for the other two. So despite the lower yield, at least its retaining its asset value.
Hi Dan,
I’m in the midst of my year-end rebalancing, and would like to simplify my portfolio. For my US equity, I currently hold XSP and VFV, but would like to sell these holdings, and then purchase VUN. However, I would be placing a large bid (approx. $250k) for VUN, and I’ve noticed that the trading volume is still pretty small. I realized that you’ve talked about this before in your blog, but I’m still nervous that my bid will not be all filled. Any suggestions for how I structure my bid, so that it will be filled in 1 day?
Thanks in advance,
Adam
@Derek: I have an inquiry in to Vanguard and they have promised me a more complete explanation about the surprisingly low yield on VRE, but a couple of things to note. The distribution yield on a REIT fund is ultimately meaningless: the distributions are a mix of fully taxable income, capital gains and return of capital, all of which affect the total return differently. VRE does not seem to distribute return of capital, while XRE has made huge distributions of ROC in the past. But paying out ROC has zero effect on the fund’s total return, because it is simply giving you back your own money.
The only meaningful measure of these ETFs’ performance is their total return, which accounts for price changes and true investment income (not ROC). Here are the numbers for the year ending December 13, according to Morningstar:
VRE: –3.45%
XRE: –8.57%
ZRE: –8.23%
So desoite its low distribution yield, VRE actually outperformed the other two funds significantly over the last 12 months. The main reason, I believe, is that VRE includes a large holding in Brookfield Office Properties (which is technically not a REIT), while this company is not in XRE or ZRE. Brookfield has performed very well in the last year (up 27%), giving VRE a boost compared to its competitors.
That is a random event and it could be the opposite next year. Indeed, this is the main reason I tend to prefer ZRE: the equal-weight index is less susceptible to the movements of a single company.
While on topic of REITs, although off topic from the post (sorry Dan), I don’t think a small portfolio allocation (up to 10% or so) of either ZRE, VRE or XRE is a bad idea…
Either investors get more ROC or less, more yield or less but over time (5+ years of investing and sticking with one product versus jumping in and out of many), they should all be relatively similar in terms of total return.
?
Mark
@Adam: Please understand I cannot offer an individual advice on any specific trade. But in general, ETFs are open-ended funds that can create new units whenever there are significant inflows: in other words, there is no danger of an order going unfilled. The worst thing that could happen is that a large order would be filled at different prices.
Any time you make a large ETF buy you should follow normal good practices: always use a limit order (perhaps two cents above the ask price); avoid placing the order right after the markets open or right before they close; make sure it’s not a US holiday if you’re buying an ETF that has underlying US holdings.
You could even call the ETF provider ahead of time and tell them you are planning to place a large trade. Advisers often do this to ensure the market makers are prepared to fill the order efficiently. I’m not sure what their minimum order size is for this service, but if nothing else they can advise you on how to ensure the order goes off without a hitch.
Good luck.