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.
- Andrew Hallam: I Just Found $35,000 – So What Did I Do With It?
- DIY Investor: A Resource for the Mutual Fund/ETF DIY Investor
- Independent Investor: The Vanguard Group, Inc. and Canadian investors
- Money Smarts Blog: Strategies for ETFs and Index Funds
- My Own Advisor: August Update – working through our 2010 financial goals
- Young and Thrifty: Exchange Traded Funds Basics
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?