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How to Invest in Vanguard Funds Using ETFs — and Save Money While You’re at It

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Falling coins. Source: http://www.flickr.com/photos/85169118@N00/3183438063/Is it possible to save money by investing in exchange traded funds (ETFs) instead of mutual funds? For many of Vanguard‘s mutual funds, this is possible. Even more importantly, Vanguard ETFs offer Canadians and people living internationally the ability to invest in Vanguard mutual funds via ETFs.

First, I’ll compare the difference between investing in a Vanguard mutual fund, and investing in a Vanguard ETF. Vanguard has an online calculator that allows you to compare the differences in costs between ETFs and mutual funds for a given investment type.

Example one: Investing in the Vanguard Total Bond Market Index Fund (VBMFX) versus the corresponding ETF (BND)

Want to invest in a broad market of bonds, but not sure if mutual funds or ETFs are better for you? Using the online calculator, I compared the following two investments:

  • Vanguard Total Bond Market Index Fund (Investor Shares) (VBMFX)
    • Management expense ratio (MER): 0.22%
  • Vanguard Total Bond Market Index ETF (BND)
    • Management expense ratio (MER): 0.12%

Note: The Admiral Shares series has a lower MER of 0.12%, but requires a minimum $100,000 investment.

Using the online calculator, I entered the following data:

  • Initial investment of $10,000.
  • Monthly investment of $200.
  • Commission of $4.99.
  • Time span of 15 years.
  • 5% rate of return.

Using this data, it turns out that I would have saved $339.12 by going with the mutual fund. The downside of ETF investing is that it’s usually done through a broker, and the broker charges commission for each transaction. With a commission of $5 per transaction, I’m effectively reducing my return by 2.5% for each monthly investment, which somewhat hurts my overall returns.

When it comes to a longer time span, however, the lower MER can swing the balance in favor of the ETF. I changed the parameters as following:

  • Increased monthly investment to $250.
  • Increased time span to 25 years.

With the longer time span and slightly larger monthly investment, the balance has now swung in favor of the ETF. I can now save $397.68 by going with the ETF.

You can adjust different parameters within the online calculator and see which scenario looks more attractive for you.

Example two: Investing in a Vanguard ETF versus a typical Canadian bank mutual fund

For those of us living in Canada, we don’t really have a choice between Vanguard mutual funds and Vanguard ETFs. For us, the choice is more between a typical selection of mutual funds at one of the large banks and Vanguard ETFs through a broker.

For my second example, I’m going to compare investing in the BMO International Index Fund versus the Vanguard Europe Pacific ETF. Both investments track the MSCI EAFE index; the ETF returns are using “market price total returns” data.

Here’s some performance data for both funds:

1 year 3 years
Benchmark: MSCI EAFE index 6.26% -10.28%
BMO International Index Fund 5.11% -12.14%
Vanguard Europe Pacific ETF 5.40% -9.67%

The interesting thing here is that the Vanguard ETF actually outperformed the index over the past three years. In the last year, it’s lagged the index somewhat, though not as much as the bank mutual fund.

If we started with a $10,000 initial investment, here’s how that investment balance would have changed over time:

1 year 3 years
BMO International Index Fund $10,511.00 $6,782.25
Vanguard Europe Pacific ETF $10,540.00 $7,370.48
The ETF advantage $29.00 $588.23

After a $5 commission, the 1 year case does not look too compelling. The differences increase over the years, though, and there is a much more significant difference after three years. You would have paid an additional $583.23 for the “luxury” of investing through your bank account over the last three years. Although both positions ended at a loss due to the global financial crisis and the ensuing turmoil, you saved money with the Vanguard ETF.

Additional ways to save money on Vanguard ETFs

For those of you living in the U.S., if you have $50,000 or more in Vanguard funds, then you can take advantage of Vanguard Voyager Services to invest in Vanguard ETFs commission free. If you cannot take advantage of commission free trading, then you can reduce relative costs by investing larger amounts, or investing less frequently. Investing less frequently, however, has to be traded against the opportunity costs of not being invested in the markets.

Further Reading

So, here are two simple examples of how it can be possible to save money using low cost ETFs. If you have the option of buying a Vanguard mutual fund, then it may be the better choice depending on your specific investing strategy. If you don’t have that option, however, and you are forced to choose between so-so bank funds and a Vanguard ETF, then the ETF can become a compelling play.

As I recently liquidated my unregistered investments for a downpayment, and my RRSP account does not offer the choice of investment in ETFs, I am currently invested in mutual funds. As I continue to generate income, however, I will be looking at ETFs in the future. How about you? Are you currently investing in ETFs? What do you think about investing in ETFs versus mutual funds?

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Comments

    • Looks like you need at least $50,000 in their mutual funds. If only Vanguard would start offering services here… you guys don’t know how dismal and bleak the mutual fund investing landscape is around here 😉

      Thanks for sharing that tip; I’ve updated the post.

  2. Great article Kevin.

    The amount and frequency you invest are also important factors. The higher the contribution amount and the more infrequent ETF purchases, make the ETFs look better.

    Your example of $200 per month is probably quite realistic for a lot of people though.

    Mike

    • Yep, I was thinking of the typical retail investor (and myself!) when writing that. I think that the case between ETFs and funds is pretty close, but as a Canadian that doesn’t have the same selection of mutual funds as those in the US, the ETFs can be much better.
      You made a good point, so I also added that in; thanks for sharing!

  3. Good info. I am currently invested in mutual funds, but have been contemplating ETFs. Still not sure which way to go. Maybe I will just buy a lump of gold instead…

    • You can always check out the calculator and see what the difference for your own personal case would be. As for gold, you might be able to get a better price in the fall if we are indeed going into a double-dip, as investors would be pulling their money out of everything and going into cash. On the other hand, if you believe in the extreme pessimists, the dollar might implode before then… 😉

  4. Good stuff Kevin,

    The examples you provided are what makes this article interesting. Unfortunately, the plan at work for our RRSPs allows only mutual fund investing. So right now I am not invested in any ETFs. However, I am planning for self directing my extra RRSP investments next year and this is where I am looking at going heavily into ETFs.

    Cheers!

    • Hey Mich,

      If I had access to Vanguard Admiral Shares at 0.12% MER, I might just go with those. I don’t know if ETFs would still have a strong advantage. However, I don’t have access to them, and the selection here just isn’t as good. I think that as I start having money for additional investments next year, I’m going to be looking at ETFs more closely, too!

  5. I have been contemplating buying ETFs instead of MF. I have been researching about the ETFs… The only thing I am still not clear about is the claims that ETFs is somehow tax efficient than MFs. I still don’t understand that advantage mentioned in various ETF articles. Do you what that is all about?

    • Hey Suba,

      I think Andrew covered it pretty good a couple of comments down, although you do have to watch out: Some active managers are starting to get in on the ETF game as well!

  6. Good post Kevin! Also, thanks for the mention under “Further Reading”.

    Somewhat of an aside, your article goes to show how international index funds have taken a small beating in recent years. Ouch.

    Back to your post, U.S. citizens have it made with their choices of Vanguard ETFs.
    From reading Vanguard’s site, I think the average expense ratio of Vanguard ETFs is 0.18% (compared to three-times as much for other U.S. ETFs). In Canada, well, you well know…

  7. I’ve been thinking about switching from my monthly mutual fund RRSP contributions to less than monthly ETF for the reasons you outlined. The Vanguard ETFs look good in terms of avg expense ratio, but can they be RRSP’ed like the Canadian ETFs?

    • Hi Kara,

      Basically, what Andrew said just below. I believe you can open RRSP self-directed accounts with discount online brokers such as Questrade.

  8. Kara,

    To answer that question, “Yes” you can hold American ETFs in your self directed RSP account.

    Suba,

    If you’re talking about actively managed mutual funds, then the turnover rate of buying and selling the stocks within the funds (within a taxable account) make ETFs more tax efficient. No active manager is buying and selling the stocks in a typical ETF.

    Great, thorough post Kevin!

    • Hey Andrew,

      I have heard that you need to watch out, as there are some ETFs that walk and talk like active mutual funds, even though they have the “ETF” label. Thanks for lending your expertise to the thread!

  9. I knew when I started reading this post I would not understand it! But gotta keep reading these investing posts so when I do decide to learn I have at least a base knowledge!

    Are these funds all long term choices? More like savings accounts with higher risk rather than trading in straight company stocks?

    • Hi Forest,

      With ETFs you can invest in a wide variety of investment choices, short-term and long-term. ETFs are similar to mutual funds in that they represent a basket of investments, except that they are traded directly on the stock market.

      If you go for an ETF which tracks a stock market index like the Europe + East Asia index or the Total World Index, then I would recommend you invest with a long horizon in mind, like a good 15-20 years or so. That’s how you ride out the variance curve as the market rises and falls, and take advantage of dips to add to your positions. 😉

  10. I was going to mention the frequency of investing as well. I am a retail investor too, but I do tend to lump my ETF purchases together to avoid paying commissions monthly. Hopefully, all the DCA people don’t crucify me for saying this though 🙂

    • Haha. I am a DCA guy myself (lump sum presupposes that you happen to have a bunch of cash lying around ;)). With ETFs I would need to consider the monthly transaction costs though and then see what would be better…

  11. Great examples. I think they give the answer. If you making frequent transactions and are in for the shortfall do it with Vanguard’s MFs. If transactions are infrequent and you’re in for the long haul go etfs. If you have enough invested use the Voyageur program as Andrew suggests.
    For myself I have to admit that I like the etfs hands down. I like to know the price I’m transacting at and the ability to get out at a known price during the day.

    • One thing I’m curious about for the Voyageur program is if you need to keep $50,000 in the mutual funds or if everything can be placed in the ETF program…

      I haven’t yet started investing in ETFs yet, but when I have some money to invest by next year I will start seriously considering them for my TFSA (Canadian equivalent of Roth IRA) and unregistered accounts…

  12. Maybe I missed something, but in example 2 (really the only valid one for Canadians) you did not include the FX costs in the initial investment, which for most people is around 2% (EACH WAY!)

    This should not deter the long term investor, but instead of looking at relative historical market returns you should be looking at the MER delta and the number of compounded years it takes to recoup the FX costs. If that number of years exceeds the investment period, you win, if not, you lose.

    • Hi James,

      You bring up a very good point regarding the FX costs. These costs are in addition to the commission, so they also have to be taken into consideration. However, MERs are more important over the long run, and I really wanted to show the advantages one could have by switching from a high-cost mutual fund to a lower-cost ETF.

      One reason for looking at relative historical market returns is that I wanted to show actual conditions, rather than hypothetical extrapolations based solely on MERs.

      I appreciate the comment, and don’t hesitate to give me your feedback in the future. I am here to learn, and these are exactly the type of comments that benefit me and everyone else.

  13. Kevin, Since Vanguard is employee owned almost all of their products are “consumer friendly” with rock bottom costs. Additionally, as you mentioned, etfs which trade on the stock markets are open to Canadian investors! As brokearge companies go, Vanguard is extremely cost effective.

    • That’s what I like about Vanguard! It’s too bad that they don’t yet offer mutual fund products to retail investors in Canada as well. At least we still have the option of the ETFs.

  14. Just wanted to add that if you open a brokerage account with Vanguard (as opposed to Etrade, Scottrade, etc) that you can purchase and sell Vanguard ETFs commission-free.

  15. Warning: long comment. I apologize before hand but I want to complement this helpful site with my own experience on wealth management . Right now, I work at a large hedge fund that primarily uses options so I’d say I have some insight into the financial sector. Between my husband and I, we’ve always looked up to Warren Buffet. When Buffett was a young man, he used leverage to became a multimillionaire by forming partnerships and sharing in their profits. He invested very little, but received a large portion of profits in exchange for his brilliant investment decisions. This was a truly win-win situation for him and his partners. My advice is to start slow with investments, read up on the award-winning thesis by Delos Chang – it really details just how great mutaul index funds are. S&P 500, in my opinion, is tough to beat if you’re looking for a decent return. Of course, if you’re investing during drug wars and mortgage housing crises..that might be a bit difficult. But if you haven’t already, take a quick read on the arguments provided in Delos Chang’s article if you’re investing in the long run – say for children (quick tip: the educational 401k exempts you from federal financial aid). If you’re looking to day trade, one advice for you: better get your stuff together because you better know more than the brokers and dealers in the NYSC!

    • i’m an expat canadian living in the u.s. since 1989 now a u.s. citizen. all assets are invested through vanguard and held in various funds & etfs. recently my dad, in canada, sold some properties and now has to decide how to invest several million dollars.

      in order to try and make some suggestions i’d like to know what the complications are for canadians investing in american etfs (e.g vanguard). i know it is possible to do so through a discount brokerage in canada but are there any additional expenses or other disadvatages that will be incurred over, say, investing in a canadian etf (claymore)?

      i’d love to hear the impressions from a canadian…in canada…who has invested in a u.s. based etf and how they did it and how things transpired over the months & years. any surprises??? any fees, expenses, or tax issues which came into play which were unforeseen?

      any insight anyone on this forum could provide would be greatly appreciated.

      thanks,
      rob

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