Last Monday, I discussed my first 2 dividend stock picks of 2011. At the same time, I have produced a complete picture of my holdings (that can now be found in the dividend holdings section in the top bar of this site). A part of my portfolio is always invested in index mutual funds. Why is that? Sometimes I feel that I don’t have enough liquidity to buy another dividend stock. Sometimes I just don’t feel like rushing my investment strategy and prefer to take a few weeks before making another trade. In both cases, I hate having money sit idle in my account. This is why I have decided to invest my liquidity in an index mutual fund.
Index Mutual Fund vs Index ETF
I have looked at both options for a while. I wanted to make sure my money was invested at all times and that I was able to cash it in to make trades if needed. Therefore, investing in a stock index seems like a reasonable option. I take less risk than concentrating on a specific stock while I still have a good chance of performing if this money is there for a few months up to a year. But why choose a mutual fund over an index ETF?… The answer is below:
Index Mutual Fund = Flexibility at a Very Low Cost
I have run into an interesting debate about ETF and index mutual funds over at another one of my blogs. My main point about going with an index mutual fund is that you can buy and sell them without trading fees. Even better than that, you can find index mutual fund at a very low MERs.
The mutual fund company I use, Altamira, offers 3 main index funds:
Canadian Index Mutual Fund
American Index Mutual Fund
International Index Mutual Fund
Their main strengths are:
#1 Their low MERs (between 0.50% and 0.60%)
#2 No front end or back end trading fees
#3 Currency hedge options (for American and International index funds)
#4 Being part of the top performers in their universes
Since I don’t want to invest more than $1,000 in a stock index product (I usually make a trade when I hit $1,500 of liquidity), buying and selling a low MER index mutual fund seemed a great alternative when compared to a regular ETF (with lower MERs but considering trading fees).
I have chosen a Canadian index for now as I believe that Canadian economic perspectives are better for 2011 than in the US. However, I might change my mind over time.
Index Fund vs Money Market Fund
Instead of putting my money on the sidelines in a money market fund at 1%, I would rather take the risk to live with fluctuations. In the end, I am looking at a 100% equity asset allocation right now. Depending of the type of investor you are, you may prefer to invest your temporary liquidity somewhere safe in order to be able to keep your money for your future trade. In my current investing strategy, I might benefit from a market surge and pick stocks faster than expected… or I can suffer from a global market loss and get stuck having to wait longer before adding another company to my portfolio. Since I’m mainly trading with my retirement account, I’m not in a hurry for profit. I guess it all depends on what you want to do with your money ;-).
As long as you’ve done cost/benefit analysis between similar ETF and MF, you are fine! I remember one Vanguard Mutual Fund which had more fees than their equivalent ETF.
One can also invest in over 100 ETFs with TDAmeritrade at zero commissions.
Interesting, I need to find out if Questrade allows me to buy such products. I know they don’t allow me to buy what was essentially cash holdings.
@ Lowell Herr,
Good point but I’m Canadian so I can’t open an account with TDAmeritrade (the funny thing is that TD is a Canadian Bank 😉 ).
@ Sustainable PF,
You can buy ETF mutual funds at no fees with any brokerage account. You just have to be careful with the funds (some have fees or MER’s are high). I like the Altamira has they have been around for a while and they have a very low MER.
Interesting. But why not use a bond index fund to preserve capital if you’re only going to use the index fund as a “holding product” until you buy a stock?
I don’t disagree with the approach, ETFs will cost you some fees when buying and selling.
I have to disagree with you.
There is normally 1 main advantage with an Index Fund.
You can usually do automatic reinvestment with an Index Fund. This option is not available for ETFs. This would be important for someone who wants to invest X number of dollars ever 2 weeks, month, year etc.
If you go with a major company such as Vanguard or Fidelity you will find many other options. I have my investments with Vanguard and they have their own ETFs which are free to trade. Also, their ETFs are usually cheaper than their index funds. Their expense ratios are nominal and almost always .25% up to .50% whether through an ETF or an index fund.
The other big advantage is you can trade out of an ETF just like a stock. If you needed cash ASAP you could sell an ETF and have cash available. If you are invested in an index fund you must wait until after the market closes before your fund is sold.
Index Funds are set and forget funds that allow automatic reinvestment. They used to have cheaper expense ratios, but no longer. If you choose ETFs in large sectors or markets you will have large liquidity and lower costs.
The easy choice is an ETF. I would suggest you move away from Altamira and into a much large company with better products and lower costs. If you only have 3 major index funds at Altamira that is a one reason alone to move.
Enjoyed your article. You will benefit from surges, but might get stuck waiting longer during global losses. Do you have an exit strategy if the global losses are substantial or do you just wait for things to turn around?
Good post. For US investors, who can access index mutual funds at extremely low cost, the benefits of ETFs are much less compelling. In Canada, the MERs on most index funds are appalling (often 1% or more), so there’s a better case to be made. TD’s e-Series funds and Altamira’s are the cheapest, although the asset class selection is very limited.
Ultimately, the cost decision is determined by the your portfolio size, the difference between the MERs, the cost of trades at your brokerage, and the frequency of contributions. I’ve worked out the math here:
http://canadiancouchpotato.com/2010/06/25/should-you-use-index-funds-or-etfs/
@Ray,
I don’t want to build a ETF portfolio, this is why following one stock market is good enough for me. Since I’m Canadian, I would only take an additional risk by tradding Vanguard ETF in US dollar (since this investment will always be in a short term position).
@Buck,
My goal is to be 100% equity all the time. Since I can’t always trade, I buy index funds in the meantime. In the end, if the market falls, chances are that my single stocks will fall at the same rate of the index (more or less). So no exit strategy. If I sell my index fund at a lower price, this will also mean that I will be buying a stock at a lower price 😉
@ Canadian Couch Potato:
interesting post! thx for your comment!
you are right, if I was trading with a bigger among on funds, I would probably choose ETF…
Hi,
Just came across your blog. nice post. One more thing to note is that mutual funds have a wait time, dont they?
Thanks
I completely agree! Why would I pay brokerage fees to purchase and top-up with Index ETF’s?
For the Bond component of my portfolio I have used the TD Canadian Bond Index e-series. Its a cheap way to build up my fixed-income portion. I like your concept of parking money in an Index Fund until you have enough for a trade. I would also suggest any investor should have a core Index holding anyway to track the market in general.
I am also in the process of setting up an additional Couch Potato Portfolio and my holdings are with TD. While a limited selection, the TD e-series funds have a very low MER. In addition I pay absolutely no fees to buy or sell (since TD has no commissions on their e-series funds). Its a win win!
Oh and I forgot one point! Yes TD does have a 90-Day wait period on their e-series funds. So if you buy you hold for 90 days or pay a penalty ^^
The iShares Canadian index ETFs XIU and XIC have MERs of 0.17% and 0.25% respectively. Buying either one through a free Questrade trading account will cost $5 in commission. That’s a one time trading fee of 0.5% on the $1,000 investment you said you would make. Held over the long term (as index investing should be), the lower MERs should cover the initial trading commission (and the $5 selling commission in the future) and should result in higher net return.
On the basis of MER and trading fees alone, your arguments are unconvincing.
The strengths of index mutual funds are in automatic reinvestment of distributions and potentially lower tracking error than some ETFs. However, in my opinion, only the ultra low MER TD eSeries index mutual funds are worth the premium over ETFs. TD eSeries Canadian Index fund has an MER of 0.31%.
Interesting idea, I haven’t looked up the MER’s yet. This may be a dumb idea, but there is a mutual fund paying 9% dividends available. It is no-load so no in and out fees, but of course you have to hold it for 90 days or you will get charged 2%. The fund is BMO Monthly Income fund and various “experts” over the years have said they wouldn’t be able to sustain that yield, including someone on Morningstar I think, but it is still the same (or at least it was last month when I last looked). I hate being uninvested to with my money so I have used this. Thanx for the good article.
@Inq,
You are right, you can trade them throughout the day. If you sell it on Wednesday, you will get your money the next day (the price will be set at the end of the day). However, in Canada, I have 3 days settlement period when I buy a stock so it’s more than enough time to trigger the sell and the buy the same day.
@Stephen,
I know, sometimes we tend to ignore mutual funds because of their MER’s but some of them are still pretty good 😉
Thanks for the information on index mutual funds and index etfs. Very relevant and well-articulated information.