This was a reader question from "Earl" as to when he should switch his retirement portfolio from mutual funds to ETF's. Here is the question straight from the horses mouth:
I currently have some registered investments that are held with Sunlife and was wanting to switch to an ETF where MER fees would be lower and to realize a better rate of return by invest in a market, rather then the decisions of a mutual fund manager.
I'm also concerned about the up-front fees for purchasing ETF's from your typical brokerage. I want to make use of dollar cost averaging but feel that these cost might remove all benefit of dollar cost averaging. Is there a certain amount of ETF units you should purchase before it becomes useful?
Many will argue that ETF's are the only way to go, and that mutual funds are the way of the past. In my opinion, this is only true if you have an established portfolio with a considerable amount of assets. Index mutual funds (especially TD-E funds) are still a great low fee way to get into the equity market for someone just starting their account with a lower balance. On top of that, mutual funds enable you to invest monthly with smaller amounts without paying any commission.
However, there does come a point where an ETF's low MER does become cheaper than an equivalent index fund. But when is that? Lets assume that the choice is between either investing in index mutual funds or iShare ETF's. A typical index mutual fund MER is around 1% where the iShare ETF's MER ranges from
0.25% 0.17% to 0.50%.
Based on $25,000 Portfolio
MER (avg 0.40%): $100/year
Annual re-balancing commission w/ 5 transactions: 5 x $29 = $145 Total: $250/year From this example, it seems that $25,000 in assets is the tipping point of whether or not it's better to go with ETF's or Mutual funds. However, this ratio will change if a discount brokerage like Questrade is used ($5 or $10/trade). Every situation is different, and you'll have to evaluate accordingly.
As a general rule of thumb, if you are just starting your portfolio, buying index or low MER mutual funds may be your best bet as you can add to your portfolio with small increments. Once your account size gets large enough, then you should consider switching from Mutual Funds to ETF's.
As a side note, if you are going to go with Index Mutual funds, there are few (if any) that are cheaper than the TD-E funds which have a low MER that ranges from 0.31% to 0.5%. The other exception is CIBC who offer a rebate off the MER of their index funds if you have a larger account.
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