Switching from mutual funds to ETFs - MoneySense (2022)

Investing

By Larry Bates on November 25, 2020

By Larry Bates on November 25, 2020

Thinking about switching from high-fee mutual funds to low-fee exchange-traded funds? An investor advocate walks through the steps—and watch-outs—to follow when you're ready.

Switching from mutual funds to ETFs - MoneySense (1)

Photo by Daniel Bosse on Unsplash

Are you considering switching from mutual funds to Exchange Traded Funds (ETFs)? If so, you are not alone. Growing numbers of Canadians are making the move. This is evidenced by 2020 fund statistics published by The Investment Fund Institute of Canada, which show net redemptions of mutual funds during September, while net purchases of ETFs were $669 million for the month and $32 billion year-to-date.

Three factors are driving this shift in investor behaviour. First, there is growing awareness that high costs embedded in mutual funds can severely limit their long-term returns. For example, consider a mutual fund with a typical 2% management expense ratio (MER), which earns an average compound annual return of 6% before costs. Investors selling their fund after 30 years would keep less than half the fund’s pre-fee total return with the rest consumed by fees. In contrast, investors in an index ETF with a typical 0.20% MER with the same 6% pre-fee return over 30 years would retain over 90% of the total return (you can run your own scenarios on the T-Rex Score calculator). Second, there are more ETFs from more sponsors than ever before and the list is growing. Third, the same big banks that dominate the mutual fund business have become the leading providers of ETFs and the online platforms that provide easy access to them.

Watch: MoneySense – BMO ETFs – Sandra Martin – ETFs and Mutual Funds fees

Most index funds are ETFs, but many ETFs are not index funds

Many people are under the false impression that all ETFs are low-cost index trackers. Not so. But it is true that the largest and most liquid ETFs are index funds that track the performance of a particular stock index, like the S&P 500, or a bond index such as the Bloomberg Barclays Canadian Bond Index. There are also “all-in-one” ETFs offered by a number of providers which package several index funds tracking diversified Canadian, U.S., and global stock and bond indexes. These convenient all-in-one ETFs come in graduated stock/bond combinations, including 80/20, 60/40, 40/60 and 20/80.

These two classes of ETFs—single-index trackers and all-in-one ETFs—offer low cost, diversification, liquidity, choice of sponsor and convenience. There are also hundreds of higher-cost ETFs, including those focused on narrow bets like gold, cannabis or crypto, as well as “actively managed” diversified ETFs created by the big mutual fund providers in an effort to maintain their overall market share as growth of ETFs eclipses mutual funds.

ETFs: with or without advice?

If you plan to make the switch to ETFs, you must first decide whether you want to pay for ongoing advice and, if so, what type and frequency of advice you need.

If your portfolio amounts to several hundred thousand dollars or more, you can find full-service advisors who will assess your circumstances, recommend an asset mix, provide additional ongoing advice and invest your funds in ETFs for an annual fee typically ranging from 1% to 1.5% over and above ETF MERs (there are some advisors who charge fees of less than 1% for those with portfolios of $1 million and higher).

If your portfolio is more modest or if, regardless of portfolio size, you want automated investing with an asset allocation that matches your needs, there are a number of robo-advisors typically charging 0.25% to 0.50% annually on top of MERs of the mix of diversified ETFs they will manage on your behalf.

If you have a good understanding of investment basics and have at least $25,000 or so to invest, you could efficiently create your own ETF portfolio through an online discount broker. Assuming you are a long-term, “buy and hold” style investor, your only significant cost will be the MERs of your ETFs. If you choose this route, or just want to check it out, try the “practice” trading accounts offered by many online brokers.

Investors who choose robo-advisors or online discount brokers but still want personal financial advice including retirement planning might consider a “fee-for-service” advisor. Fee-for-service advisors don’t sell financial products, so they are free from the conflict afflicting the majority of Canadian financial advisors whose compensation is based on the products they sell. Depending on the complexity of your circumstances and how frequently you need advice, supplementing do-it-yourself or robo investing with a fee-for-service advisor may be a very cost-effective choice.

Open a Wealthsimple Trade account for commission-free ETF trading* >

Choosing your new investment firm

Unless you want to switch from mutual funds to ETFs through your current advisor (assuming they provide access to ETFs) or if you have an existing online discount brokerage account, you must open investment accounts at a new firm. If choosing an online broker or robo-advisor, make sure to shop around and find the features and pricing that best fit your circumstances. Once you choose your provider, you will be guided through an online application process, which will include selecting the types of accounts you need and specifying the accounts at your old firm that you want transferred. Make sure to transfer registered accounts to a matching registered account at your new firm. In other words, transfer assets from your old RRSP into your new RRSP, from your old TFSA into your new TFSA, etc. This ensures the tax-advantaged status of your registered accounts is not disturbed.

(Video) ETF vs. mutual fund fees

There are two ways to transfer your assets to a new investment firm, both of which can take a week or two. Selecting a “cash” transfer will result in your old firm selling all your positions and delivering cash to your new accounts. Some robo-advisors require cash transfers as your funds will be invested immediately upon receipt in a diversified ETF portfolio. Selecting an “in-kind” transfer means your existing mutual funds, stocks and bonds will be transferred into your new accounts as-is. Choosing an in-kind transfer will enable you to dispose of your mutual funds and any other unwanted positions coincident with your new ETF purchases, which mitigates the risk of missing potential market gains while your assets are sitting in cash.

If you switch to ETFs in non-registered accounts, you will be subject to capital gains tax on any mutual funds you sell. The long-term fee savings from switching to low cost ETFs can often outweigh the tax impact (remember, you would eventually be liable for capital gains tax in any case). Also, your old firm might hit you with a parting gift in the form of transfer fees. Worse still, if your former advisor sold you Deferred Sales Charge or DSC mutual funds, you may incur a penalty for getting out. Once again, in my experience, long-term fee savings usually exceed the one-time penalties arising from this particularly egregious form of mutual funds.

Build your ETF portfolio

If you choose a traditional advisor or a robo-advisor, a portfolio will be recommended to you. If you choose to do it yourself through an online discount broker, take these steps:

  • Determine your overall portfolio asset allocation—in other words, the proportion of stocks versus fixed income (bonds/GICs). Asset allocation is a balancing act between the opportunity to earn a good return and the risk that goes with it. Consider your investment objectives, time frame and comfort level with the roller coaster ride that comes with owning stocks. This will be your most important investment decision.
  • Choose among Canadian, U.S. and global markets. Given the small size and breadth of the Canadian stock market, constructing a diversified portfolio requires inclusion of ETFs holding non-Canadian stocks (all-in-one ETFs do this for you).
  • Choose the types of ETFs that best suit your needs: index, all-in-one or active.
  • Select your ETFs. The CETFA websiteprovides lists of top ETFs, and all major providers have websites providing full details.
  • Adjust your portfolio when, as a result of changing markets, your asset allocation drifts significantly away from your desired ratio (all-in-one ETFs do this for you).
  • Adjust your asset allocation over time as your circumstances change.

Whether or not you decide to pay for ongoing advice, if you are considering ditching your high-cost mutual funds, a simple, diversified, low cost portfolio can be built with three to four ETFs, or even just a single all-in-one ETF. And remember, before you make the switch, taking some time to brush up on investment basics will help you make better-informed decisions. As Warren Buffett declared: “The best investment you can make is in yourself.”

Watch: The different types of ETFs available for investors

Larry Bates is the author ofBeat the Bank: The Canadian Guide to Simply Successful Investing and is an investment advisor with Aligned Capital Partners Inc.

MORE ON INVESTING:

  • Best online brokers in Canada
  • A guide to the best robo-advisors in Canada
  • What does a fee-only financial planner do, exactly?
  • Potential tax changes due to COVID-19

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If a link has an asterisk (*) at the end of it, that means it's an affiliate link and can sometimes result in a payment to MoneySense (owned by Ratehub Inc.) which helps our website stay free to our users. It's important to note that our editorial content will never be impacted by these links. We are committed to looking at all available products in the market, and where a product ranks in our article or whether or not it's included in the first place is never driven by compensation. For more details read our MoneySense Monetization policy.

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Growing numbers of Canadians are making the move.. If your portfolio amounts to several hundred thousand dollars or more, you can find full-service advisors who will assess your circumstances, recommend an asset mix, provide additional ongoing advice and invest your funds in ETFs for an annual fee typically ranging from 1% to 1.5% over and above ETF MERs (there are some advisors who charge fees of less than 1% for those with portfolios of $1 million and higher).. If you have a good understanding of investment basics and have at least $25,000 or so to invest, you could efficiently create your own ETF portfolio through an online discount broker.. Unless you want to switch from mutual funds to ETFs through your current advisor (assuming they provide access to ETFs) or if you have an existing online discount brokerage account, you must open investment accounts at a new firm.. Once you choose your provider, you will be guided through an online application process, which will include selecting the types of accounts you need and specifying the accounts at your old firm that you want transferred.. (Video) ETF vs. mutual fund fees. If you switch to ETFs in non-registered accounts, you will be subject to capital gains tax on any mutual funds you sell.. Choose the types of ETFs that best suit your needs: index, all-in-one or active.. And remember, before you make the switch, taking some time to brush up on investment basics will help you make better-informed decisions.. Watch: The different types of ETFs available for investors Larry Bates is the author of Beat the Bank: The Canadian Guide to Simply Successful Investing and is an investment advisor with Aligned Capital Partners Inc.. (Video) The different types of ETFs available for investors | ETF Academy: Lesson 3. How to Make One Million in Stock Market or Mutual Fund. What is an ETF?

However, depending on what you want to get out of your portfolio and your risk tolerance and investing strategy, it may be time to switch from mutual funds to exchange-traded funds.. Mutual funds and exchange-traded funds (ETFs) share many benefits.. More recently, exchange traded funds (ETFs) have gained favor, as they behave much like mutual funds but solve several of these drawbacks.. Also, like mutual funds, ETFs may invest in different securities depending on the goals of the fund in question.. Unlike mutual funds, however, ETFs are primarily passively managed funds that generally invest in the same securities as a given index.. In addition, the market-based trading of ETFs means no assets need to be sold off to fund shareholder redemptions , as is common with mutual funds.. However, if you are looking to make a single large investment rather than several small purchases over time, ETFs can be vastly more affordable than mutual funds.. Unlike mutual fund investment, which requires a thorough analysis of the manager's track record, investing in an indexed ETF requires only that you be bullish on the underlying index.. Both mutual funds and ETFs have their benefits, but it may be time to assess whether the investments in your portfolio are serving your goals in the most effective way.. If your current investment is in an indexed mutual fund , look for an ETF that accomplishes the same thing at a much lower cost.. If you prefer an actively managed fund that seeks to beat the market, mutual funds certainly offer more options than ETFs, though high-risk/high-reward ETFs are becoming increasingly common.

If you own shares of a mutual fund that plans to convert into an ETF, the mutual fund will notify you.. If your mutual fund shares are held directly with the mutual fund, you need to open a brokerage account to hold shares of the ETF.. Redeem your mutual fund shares back to the mutual fund before the fund converts to an ETF.. Mutual fund shares are bought and sold through the mutual fund and often do not require you to hold the shares in a brokerage account.. If you own fractional shares of the mutual fund, they may be redeemed and converted to cash by the mutual fund before the conversion.. Mutual fund investors holding shares in a taxable account generally have to pay taxes on any capital gain distributions they receive from the mutual fund.. Because ETFs require somewhat different services to operate than mutual funds, ETFs have tended to be less expensive to operate than mutual funds that invest in a similar manner.. Unlike mutual fund shares, which are bought and redeemed through the fund, ETF shares are bought and sold on national securities exchanges.

ETFs and other index products have been raking in the assets during the past few years, and much of that asset growth is coming from advisors shifting out of traditional mutual funds.. Most of all, I don't know her advisor.. Here are the key questions to answer before making a shift.. Advantage : Shifting to ETFs.. Advantage : Shifting to ETFs.. 4) Does your portfolio already include a sizable share of traditional stock index funds?. Yes: Although ETFs have historically done a good job of limiting taxable capital gains, particularly relative to actively managed funds, so have traditional broad stock market index funds.. Even though low costs are a big selling point of ETFs, good broad-market index funds also have low costs.. No: ETFs often have lower costs and better tax efficiency than actively managed funds.. Advantage : Shifting to ETFs.. Advantage : Shifting to ETFs, provided your total portfolio management costs aren't going higher.. Advantage : Staying put (assuming you're not paying commissions to buy and sell the traditional mutual fund holdings that are currently in your portfolio).. Advantage : Shifting to ETFs.

Eager to give the public what it wants, and to keep shareholders from walking out the door with their assets, some fund providers have begun to convert stock mutual funds into E.T.F.s.. over the mutual fund.”. The decision to test the conversion concept was not all that easy for Guinness Atkinson Asset Management, which was the first fund provider to do it, said Todd Rosenbluth, director of E.T.F.. Jim Atkinson, Guinness Atkinson’s chief executive, said the plan was studied for two years.. It plans to convert six stock mutual funds into E.T.F.s, with the first four conversions set for June.. E.T.F.s are cheaper to run in part because the management company can stay out of the way and let buyers and sellers deal with one another.. Converting a mutual fund to an E.T.F.. Vanguard is using a different technique to let investors in 47 of its index mutual funds, 36 that own stocks and the others bonds, move their assets into E.T.F.s free of tax consequences.. Other fund providers run E.T.F.. Indeed, several of the largest fund providers — BlackRock, Vanguard, T. Rowe Price and Fidelity — said they had no intention to convert their mutual funds.. There are two reasons that conversions are more appealing to smaller firms.. Mr. Atkinson said that is the case with the two funds that have been converted.. But large funds may need several days to execute significant portfolio changes to avoid moving the market.. If a mutual fund in a frothy market segment attracts too much money, making managing the portfolio unwieldy, the manager can limit new investment, but that isn’t allowed with an E.T.F.

2 ETF product development has also evolved over this period with the introduction of more complex quantitative ETF strategies, as well as growth in actively managed strategies in the ETF wrapper.. While managers may consider launching an ETF clone of an existing mutual fund, many disfavor that approach for fear that the ETF would cannibalize the assets of the mutual fund.. Managers can meet these goals through either (1) a conversion of the mutual fund into an ETF, or (2) a reorganization of the mutual fund into a new affiliated ETF via a merger, meeting the requirements of Rule 17a-8 under the Investment Company Act of 1940 (the “1940 Act”).. In the US, ETFs only have one share class and firms should consider the best path forward to collapsing the mutual fund share classes ahead of a reorganization to an ETF, if necessary.. Managers considering an ETF reorganization should be aware that any unrealized gains or losses in the mutual fund will carry over to the ETF.. While ETFs enjoy many of the same operational requirements as a mutual fund, there are unique, day-to-day requirements that a firm must be aware of and monitor to support a new ETF business.

February/March is always our annual RRSP issue and until a year ago, that issue featured Suzane Abboud ‘s Best Mutual Funds .. Suzane used to write a regular mutual fund column for us throughout the year but decided to take a break from it.. A year ago, we introduced the MoneySense ETF All-Stars , written by Dan Bortolotti with the assistance of a small panel of ETF experts.. Instead, we opted to align the mutual fund package with a philosophy Suzane had espoused in one of her last regular columns.. Given the very low payouts on most bonds, and the relatively higher MERs charged by most bond mutual funds (compared to bond ETFs), she felt it made more sense to focus on those mutual funds that at least had a good shot at beating the indexes and justifying their slightly higher MERs: that is, stock or equity mutual funds.. Not that those bad habits have hurt the mutual fund industry.. One reason for the continued popularity of mutual funds is the comfort some investors find in so-called “active” security selection, which tends to be accompanied by the “advice” preferred by the salesperson who supplies funds to retail investors.

Now at least three fund issuers intend to convert some of their mutual funds to E.T.F.s.. Dimensional Fund Advisors doesn’t expect to convert any additional mutual funds, said Marlena Lee, global head of investment solutions for the company.. Only 32 percent of mutual fund issuers posted net inflows of cash in 2019, compared with 74 percent for E.T.F.s, according to the Investment Company Institute , a trade group.. And because of the way mutual funds are structured, investors can find themselves owing capital gains taxes at the end of the year, even if they didn’t redeem shares and even if the share price ended the year with a loss, a surprise that is unlikely for E.T.F.. “With mutual funds, you don’t know the real price,” Mr. Atkinson said.. “With an E.T.F., you can put a market order in and know what the price is.. A lot of advisers don’t like putting their clients in a position where they don’t know the price until the end of the day.”. Guinness Atkinson has been working on converting these funds since mid-2018.. That included negotiating with regulators and contacting shareholders.. That will save shareholders of the converted mutual funds from paying taxes because of the change.. “The managers claim that these are actively managed funds, and they could be more actively managed than current E.T.F.s, but I prefer a mutual fund with more of a long- term approach,” Mr. Polcari said.

To understand how to switch mutual funds, we need a clear understanding of what is the difference between direct and regular investments, what does switching involve, and most importantly, when to switch.. If you were to switch fund houses, it is known as ‘Switch-in, switch-out’, where you switch out your mutual funds from one fund house and switch into another.. As we have seen previously, switching within the same fund house involves switching between schemes or from a regular to a direct plan.. There can be several reasons for switching funds – change in investor objectives, low-performance of current fund scheme, or a desire to handle mutual funds by themselves.. As you switch mutual funds, make sure that you have an appropriate asset allocation strategy and select a suitable fund plan, which allows you to diversify effectively.. If you are sure you want to switch from a regular plan to a direct plan, you can easily switch funds both online and offline.. Step 1: Go to your mutual fund office Step 2: Request a transaction-switch form and fill in all the details, such as your fund name and folio number, as well as the target scheme you want to change to.. A good idea is to invest in direct mutual funds through a zero-commission financial advisor, like Orowealth, which combines the advantage of expert financial guidance with the high-returns of direct mutual fund investments.

Mutual funds and ETFs can both give good diversification, but mutual funds typically have much higher fees.. But because these funds are actively managed, the fees can be quite high.. The management fees charged to you is called the MER – management expense ratio.. In addition, mutual funds may also charge fees when you purchase or sell your mutual funds, which can be hundreds of dollars and up.. Source: The Motley Fool The only other fees you face are when you purchase and sell ETFs, which range from about $10 per trade at the big bank investment companies, to $0 ETF purchases at Questrade .. Index funds can be either ETFs or mutual funds.. But if mutual funds are no longer meeting your needs, if you feel you are not receiving good investment advice for the amount you pay in MER fees, the time may be right for switching.. If you have a significant amount invested in your registered retirement fund or tax-free savings account, the savings in management fees can be substantial.. Your mutual fund investments may be with one of Canada’s big banks, or with an investment company.. While it may or may not have the same name recognition as the banks, Questrade has been in Canada for over 21 years.. If you invest in mutual funds in an RRSP, you will need to open an RRSP investment account.. It’s unlikely to make a big difference in the ultimate value of your RRSP or TFSA in the long run.. You would purchase just this one ETF, and within that you would be invested in stocks and bonds from Canada, the U.S., emerging markets and other international stock markets, as well as bonds from Canada and the U.S. (as of 2021).. You can invest in asset allocation ETFs as well as other types of ETFs within your registered retirement account or TFSA.

Vanguard Dividend Growth was the original anchor equity holding in my model "bucket" mutual fund portfolios for retirees , but it closed to new investors three years ago.. It was already the anchor U.S. equity holding in my ETF bucket portfolios , though I used the traditional index fund in my mutual fund portfolios.. Another mitigating factor in the decision-making is that some investors won't owe taxes on their capital gains at all, even if they're selling from a taxable account.. If your income, including your capital gains, falls beneath those thresholds, selling won't trigger any extra tax costs.. In the case of the swap from Vanguard Dividend Appreciation to Vanguard Dividend Growth, taxable investors have good reason to pause.. In the case of Vanguard Dividend Appreciation, for example, if you own it on some platform other than Vanguard's, you're likely to pay a charge to sell and another to buy Vanguard Dividend Growth in its place.. Question 3: How similar are the strategies and portfolios?. However, Vanguard Dividend Growth's current portfolio lands in the large-growth square of the Morningstar Style Box, whereas Vanguard Dividend Appreciation's current portfolio lands in large blend.. Perhaps more significantly, because Vanguard Dividend Appreciation tracks the Nasdaq U.S. Dividend Achievers Select Index, it obviously has less latitude to make changes in response to market conditions and other factors than the actively managed Vanguard Dividend Growth.. Question 4: How do expenses compare?. Its manager's active decisions, rather than the expense differential, is likely to have a bigger impact on its performance relative to Vanguard Dividend Appreciation.. While low expenses should provide Vanguard Dividend Appreciation with an ongoing advantage, I didn't place a big emphasis on the cost difference when deciding whether to stick with the index fund or opt for the active fund.. One of the big benefits of index funds and ETFs relative to actively managed funds is that they allow you to be pretty hands-off, especially if you opt for index funds that track broad market segments like the U.S. stock market, international stocks, or high-quality U.S. bonds.. In the case of raw returns, Vanguard Dividend Growth compares favorably to Vanguard Dividend Appreciation: Since the latter's inception in 2006, its returns have edged past those of the S&P 500, whereas Vanguard Dividend Growth has beaten both by a solid margin.

He graduated from Columbia University with a B.A.. He is also the co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” and the Wall Street Journal article “The Great American Bond Bubble.”. Christopher Gannatti:. Christopher Gannatti began at WisdomTree as a Research Analyst in December 2010, working directly with Jeremy Schwartz, CFA®, Director of Research.. Prior to joining WisdomTree, Tripp worked for TD Ameritrade as a fixed income specialist.. The Capital Markets group is involved in all aspects of the WisdomTree ETFs including product development, helping to seed and bring new products to market, as well as trading strategies and best execution strategies for the client base.. Thinking about operations is not the glamorous side of investing, but it is a key component to achieving a smooth transition and your investment goals.. Therefore, investors would want to execute their ETF trade very close to the U.S. market close or work with their broker to execute a NAV trade.. Therefore, when switching from a Mutual Fund with international underlying securities, investors will want to trade the ETF at or into the U.S. market close.. The Capital Markets group is involved in all aspects of WisdomTree ETFs, including product development, seeding and bringing new products to market and working with the client base on trading strategies and best execution strategies.. Michael also supports the trading community on providing liquidity and works closely with Hedge Funds on trading and investing in WisdomTree ETFs.. Since joining WisdomTree in 2013, Michael spent a year and a half as an integral member of the sales team and later joined the Capital Markets group to concentrate on his passion for ETF markets and trading.

But that's not to say your decision about whether to invest in an ETF or index fund should begin and end with the cost analysis.. At first blush, it may not seem like a big deal if a traditional index fund costs 0.15% and an ETF charges 0.06%, but over time that 0.09% expense differential can result in a meaningful return difference.. Use Morningstar's Cost Analyzer tool to see how much you could save if you were to swap your index fund for a lower-cost ETF; the tool factors in both expense ratios as well as any commissions you'd need to pay to buy or sell your shares.. If the index fund's net asset value is currently higher than your cost basis, you'll owe capital gains tax when you sell, and you may not save enough over the life of your ETF investment to make up for the tax hit.. If your index fund is trading below what you paid for it, you could sell, book the tax loss, and swap into a similar ETF.. That means that for your tax loss to be allowable, you'd need to either wait 30 days after selling out of the index fund to buy an ETF that tracks the same index, or buy an ETF that tracks a different index.. With traditional index funds, the prices of all of the securities in the portfolio are aggregated at the end of each day, so the fund's NAV simply reflects that value, divided by the number of shares of the fund.. But ETFs also have a market price, which is the value that investors are willing to pay for each share of the ETF at any given minute during the trading day.. One of the chief benefits of both ETFs and traditional index funds that track broad stock market benchmarks is that they're apt to be more tax-efficient (that is, they pass on fewer taxable capital gains to their shareholders) than actively managed mutual funds, whose higher turnover rates can mean higher tax bills.. Although ETFs haven't always been more tax-efficient than comparable traditional index mutual funds, over time ETFs have more tools on hand to keep the tax collector at bay than do traditional index funds.. Setting aside the question of whether these techniques are advisable for most individual investors (and I'd argue that they're not), it's worth noting that ETFs offer a greater range of trading tactics, including the use of options and intra-day trading, than are available for investors in traditional index mutual funds.. ETFs don't have minimums, unlike traditional index mutual funds, making them a good choice for investors who like indexing but don't have a lot of money to get started.

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