It’s been a while since I’ve responded to reader mail through a blog post, but I thought this had some great questions that come up often. This particular reader has questions regarding ETFs vs no load mutual funds, and where to start on his financial journey.
1) Is it true that ETFs and no-load mutual funds are the same? If not, what are their differences and advantages?
2) As a new investor, who recently opened a Questrade account based on your brokerage comparison, I need your advice of where to start in creating a low-cost portfolio. Here is my current financial situation:
- I have $8,000 in HELOC debt (which I would like to pay off sooner than later.
- Have a $20,000 interest-free car loan
- Mortgage: 174,000
- Would like to have an emergency fund
- Focus on conservative/moderate growth investments
- Focus on investments that produce a monthly income
- Variable mortgage rate: 2.2%
- Income: Over $80,000
- Province: Ontario
I would be interested in your opinion of where I should begin in order have reasonable financially secure future.
ETFs vs No-Load Mutual Funds
Seems like the reader is looking to jump head first into investing and is looking for answers. To start, ETFs and no load mutual funds are not the same. No load mutual funds are mutual funds without the upfront (or backend) fees. Yes, there are actually mutual funds out there that charge client fees for the privilege of buying the fund (yes I’m serious). A number of mutual funds with sales loads offer them as a deferred sales load. While they do not charge anything upfront, the longer you hold the mutual fund, the lower the sales load they charge once you sell the fund.
While there is a place for mutual funds, the only mutual funds that I like are the low cost index kind, which mean they are no-load AND they have a low management expense ratio (MER). I like index mutual funds for portfolios that are just starting out (<$20k) as there are no commissions for buying/selling, in addition to the ability to purchase partial units (fixed dollar amount contribution per month etc). A recommended place to start is with the TD e-Series funds.
Once the portfolio balance grows, it will soon approach time to switch to ETFs. While an index ETF will essentially have the same holdings as an index mutual fund, there are a couple of differences. One significant difference is that ETFs (Exchange Traded Funds) trade like stocks on a stock exchange. This basically means that the investor will have to pay commissions for buying and selling the ETF (some brokers offer free ETF trades). So with the extra fees of buying/selling, why would an investor switch from mutual funds? Although ETFs also have MERS, they are generally lower than the equivalent index mutual fund. Over time, and with growing portfolios, this can add up to thousands per year in savings.
The Next Step?
The reader is also looking for the next step for a secure financial future, but appears to be focused on investing. To me, paying off debt is the top priority as it frees up cash flow and relieves a psychological burden. But there are a few prerequisite steps to complete.
- Establish Positive Cash Flow – With a decent income and a manageable mortgage, creating a budget to create positive cash flow is a must.
- Start an Emergency Fund – While it’s debatable on how much to put in an emergency fund, I think it’s a good idea to have one. As the reader is interested in starting one, I think enough cash to cover 3 months expenses is a good place to start. Once that is established..
- Pay off Debt -The HELOC mentioned is likely charging 4% interest (prime + 1%), although it’s a relatively low rate, its gotta go. I would leave the car loan until the term is up because it’s free money. Once the HELOC is payed off, time to focus on the mortgage by paying it off as soon as possible. If not already setup, increase payment frequency to accelerated bi-weekly, top up payments and pay lump sums when cash is available. For more mortgage tips, check out how we paid off our mortgage in three years.
- Invest – Once debt is eliminated, it’s time to take all that freed up cash flow and invest. As I mentioned, if just starting out, I like low cost index mutual funds, and then move to index ETFs when the portfolio becomes larger. Since the reader already has a discount broker account opened, here is an example of a low cost ETF portfolio to consider.
What are your thoughts? Do you have anything to add to the reader questions?
Do you have a financial question? Feel free to send them to me here. Note that due to high volume of email, it may take several days to get a response, but I’ll get to it as quickly as possible.
Disclaimer: This article should be used for informational purposes only.