Canadian investors know that the easiest way to build a diversified portfolio is through low-cost index funds. But after all, what is an index fund? Isinvestment fund? EInvestment fund(ETF)? Both? The truth is that in recent years the lines between index mutual funds and ETFs have become blurred.
In this article, I explain what an index fund is, the differences between index mutual funds and ETFs, and share my list of the best index funds in Canada. Here's a tip: the list includes mutual funds AND ETFs.
What is an index fund?
Eindex fundis a type of mutual fund or exchange-traded fund (ETF) that attempts to track the performance of an underlying stock index, such as the S&P/TSX Composite Index in Canada or the S&P 500 or Dow Jones Industrial Average in the US.
Index fund managers buy the same stocks in the tracking index. Depending on the fund, they may also match the weighting of each stock within the index or assign each stock an equal weighting.
In any case, index fund managers follow a passive investment strategy. They're not looking to do regular business; Your goal is to achieve returns that match the benchmark. This approach keeps the cost of managing index funds very low, which benefits investors.
Swindleractively managed mutual funds, managers regularly buy and sell stocks in an attempt to achieve above-market returns. And occasionally they do just that, although history shows that actively managed mutual funds almost always underperform their passive counterparts (index funds). Part of the problem is fees.
Increased activity in an actively managed fund increases expenses, which results in higher management and administration fees, which reduces the investor's return. Actively managed mutual funds can charge fees of 2% or more annually, while passive index mutual funds typically stay well below 1%. Exchange-traded funds are even lower, with some MERs below 0.10% per annum.
Mutual fund indexed against ETF indexed funds
Index mutual funds and index ETFs have many similarities. In fact, mutual fund companies have been blurring the lines lately, keeping ETFs within their index mutual fund products as a way to cut costs. Some index mutual funds even include ETFs in the name, which can be confusing (BMO does this).
Both types of investments contain a large number of underlying assets such as stocks and bonds, and both follow a passive investment strategy. The biggest difference between the two products is that ETFs can be traded like stocks on an exchange, while mutual funds can only be bought once a day, making ETFs slightly more liquid than mutual funds.
Another differentiating factor is the low cost of ETFs. Rates on index mutual funds have fallen in recent years as investors have turned to individual stocks and ETFs, but ETFs remain the cheaper of the two. It is common to find broad market index ETFs with MERs below 0.10%.
The Best Index Funds (and ETFs) in Canada
I've separated our list of Canadian index funds into two groups: the mutual fund version and the ETF version. Given the latter's popularity, I've included three index mutual funds and six ETFs. I classified the funds incanadian stocks, US stocks and international stocks. For this post, I excluded funds in smaller categories like bonds, small caps, or emerging markets.
The best index mutual funds
You'll notice that two of the three funds on our list are TD eSeries funds. TD has led the way with this family of funds for many years, and while ETFs appear to be the future (and present) of index investing, TD continues to invest in eSeries. In recent years, they've found unique ways to cut costs even further. Also, you can now buy TD eSeries funds from a number of Canadian online brokers, which has not always been the case. I've also included a long-standing RBC index mutual fund on our list.
Canadian TD-e index
Management Expense Index (MER):0,28%
Assets under management (AUM):$1.5 billion
3 main holdings:TD Canadian Equity Index ETF (34%), Royal Bank (4,1%), TD Bank (3,6%)
What we like:One of Canada's largest index funds with a very low MER.
The TD Canadian Index fund uses the Solactive Canada Broad Market Index as a benchmark. The index is designed to track the performance of the full-cap segment in the Canadian stock market. The fund's largest holding is a TD ETF (TTP), but it also has individual stocks for greater exposure to specific sectors such as financials and energy.
RBC U.S. Index Fund F
Management Expense Index (MER):0,21%
Assets under management (AUM):$500 million
3 main holdings:Apple, Microsoft, Amazonas
What we like:Exposure to the S&P Total Return Index
If you're looking for exposure to the S&P 500 in an index mutual fund, the RBC U.S. Index Fund F is a solid option. The fund has a low MER of just 0.21%
International Variable Income
TD International Index – and
Management Expense Index (MER):0,46
Assets under management (AUM):$688 million
3 main holdings:TD ETF International Variable Income Index (TPE), iShares MSCI EAFE ETF
What we like:No trading fees when purchased through TD Direct Investing
TD's eSeries Index Mutual Funds are able to reduce costs by holding other ETFs instead of individual stocks. Not only that, but they have started tracking Solactive indices in recent years to save additional costs.
This fund is benchmarked against the Solactive GBS® Developed Markets ex-North America Large & Mid Cap CAD Index. Its main holding is the TD International Equity Index ETF (TPE), which I cover in more detail below.
Best Canadian Index ETFs
Canadian investors can choose from over 1,000 Canadian-listed ETFs, but I have selected six of the top performers in their respective categories for several reasons.
1. Vanguard FTSE Canada All Cap Index ETF
3 main holdings:Banco Real, TD, Enbridge
What we like:MER low of 0.05%, maximum exposure
The Vanguard FTSE Canada All-Cap Index ETF is a highly diversified Canadian ETF. It gives investors exposure to the entire Canadian market, with small, mid and large cap stocks. The ultra-low MER of 0.05 is among the lowest in the industry.
iShares Core S&P/TSX Limited Composite Index ETF
What we like:Like the VCN, the iShares Core Composite Index ETF with S&P/TSX Capitalization has a very low MER (0.06%). The fund invests in the largest and most liquid Canadian companies listed on the TSX; however, individual holdings are capped at 10% to avoid being overweight in any company.
iShares Core S&P US Total Market Index ETF
What we like:Access to the entire US market.
If you want exposure to the entire US stock market in Canada, this is the way to go. Unlike the S&P 500 ETFs, the iShares Core S&P U.S. ETF. The Total Market Index covers more than 3,500 small, medium and large companies. The MER is a paltry 0.07%.
Vanguard S&P 500 Index ETF
What we like:Ideal for exposure to the largest American companies.
Vanguard's S&P 500 Index ETF provides investors with exposure to the largest companies in the United States. The massive fund, with more than $7 billion in assets under management, has an MER of just 0.09%. If you own small and mid-cap US stocks in another ETF or just want exposure to the biggest companies, this is a great option.
International Variable Income
iShares Core MSCI All Country World ex Canada Index ETF
What we like:A truly global ETF,
Remember that you cannot achieve true diversification without exposure to markets outside of Canada. iShares Core MSCI All Country World ex Canada Index ETF is a global fund with a reasonable MER of 0.22%. Remember that it has a weight of 60% in the North American market. You may decide it's too much if you already have exposure through a US equity ETF such as VFV.
In that case, the next ETF on our list might be a better fit.
TD ETF International Stock Index
3 main holdings:Nestlé SA, Roche Holding AG, AstraZeneca PLC
What we like:MER bajo, ex EE. UU.
If you already own a US ETF or index fund, the TD International Equity Index ETF (TPE) could be a perfect fit for your portfolio. Aside from an incredibly low MER for an international fund, TPE has almost no US exposure (1.0%). It is mainly focused on the Asian and European markets, with 38.0% and 28% of shares, respectively. Notable holdings include Nestlé SA, Shell and Toyota Motor Company.
How do I add index funds to my portfolio?
If you're ready to buy index funds, the next step is to add them to your portfolio. Most investors should consider index funds or ETF principals due to their low cost and the diversification they offer. Because index funds have so many underlying securities, you can build a well-diversified portfolio without large sums of money.
However, you should consider including the right mix of index funds. For example, you must make sure you have exposure to the Canadian, US and international markets.
You can do this in several ways, but one way is to buy three index funds: a Canadian fund, a US fund and an international fund. If you have a dedicated US fund, just make sure your international fund is outside the US to avoid overexposure to that market. That's one of the things I like about the above TPE: I don't have to worry about my US holdings overlapping.
If you use a three-fund wallet, keep in mind that you will need to take care to rebalance these funds regularly. For example, let's say your portfolio is split 40/40/20, with 40% Canadian, 40% US, and 20% International. Over time these weights will change and you could end up with something quite different, say 60/30/10.
When that happens, you'll need to trade and adjust each fund's balances to maintain your desired weighting, say 40/40/20. Rebalancing can take a long time, and if you have trading fees, it can also cost you money.
To avoid inconvenience, you can buycomplete ETFsinstead of. You can keep your entire portfolio in one fund with an all-in-one. They cost more, but the funds are rebalanced for you, so there's no work on your part.
For more information, see my article on thebest all-in-one ETFs in canada.
Other Portfolio Considerations
Keep in mind that the index funds included in this article are all equity funds. They invest almost exclusively in Canadian, US and international equities and offer little or no exposure to income investments such as bonds or real estate.
As you invest, you will want to decide how much of your portfolio should be in stocks and how much should be in low to medium risk investments such as bonds, real estate, etc.
To reduce portfolio volatility, the vast majority of investors should have a combination of income and equity investments.
You should always consult an investment professional to determine your optimal asset allocation. They will consider your overall investment objective, time horizon, risk tolerance and other factors.
Where can I buy index mutual funds and ETFs?
You can purchase mutual funds through a financial adviser at any Canadian bank or credit union; however, ETFs can generally only be purchased in person from a banking adviser if they are properly licensed.
The easiest and most convenient way to buy mutual funds or ETFs is to open an online brokerage account. This way, you can manage your portfolio and transact from the comfort of your living room.
Fullat least a dozen online brokers in Canada. TD Direct Investing is great for mutual funds as they don't charge trading fees on hundreds of funds. Unfortunately, they charge $9.95 to trade stocks and ETFs.
For ETFs, I recommendQuestradeoWealthComercio simple.
You can open a Questrade account online and start trading as soon as you deposit funds into your account. The best part about Questrade is that they offer free ETF purchases. The same goes for Wealthsimple Trade, although its platform lacks the functionality of Questrade. Please note that Questrade charges $9.95 for mutual fund transactions.
Click here to start using Questrade
If your portfolio consists primarily of investments in actively managed mutual funds, it might be time to consider switching to passive mutual funds or ETFs. The problem with owning traditional mutual funds is that you are paying higher costs for what is likely to be poor performance.