U.S. ETF prices come to Canada

Ultra-cheap ETFs have arrived.

CB_Chicago Mercantile Exchange

It’s been a few years since we’ve had a good old-fashioned gas-price war at the pumps. But most of us can still remember the vehicle lineups. Some car owners even filled Jerry cans to squeeze every last ounce of value from the temporarily depressed fuel costs. A few bucks saved on a couple tanks of gas is one thing; but that’s peanuts compared to what you could save during the price war now raging at an investment brokerage near you. It’s a marvel what a little competition can do for a marketplace.

When the Vanguard Group announced a lineup of Canadian-listed exchange-traded funds (ETFs) nearly two years ago, it knocked the wind out of our domestic ETF providers. The U.S. firm vastly undercut Canadian fund prices on offer at the time. The battle that’s now ensuing could save investors tens of thousands of dollars, and best of all, unlike fuel prices, the lower expense ratios on today’s ETFs won’t revert to the higher prices of yesterday. Based on the cost-slashing precedent in the United States, they could actually drop further still.

How far have they fallen, and how much can an investor save? The lowest-cost ETF that holds securities on the TSX is Vanguard’s MSCI Canadian Index (VCE). It tracks 100 large cap Canadian stocks, representing roughly 85% of the TSX market cap. Charging a management fee of just 0.09% each year, it sips costs like a Smart Car, compared to the fee-guzzling 2.4% charged by the typical actively managed mutual fund. An active fund manager would have to outperform the market by roughly 2.3%, before fees, just to match the returns of Vanguard’s index.

Thanks to Vanguard’s other fresh options, if you’re looking to build a diversified international portfolio of Canadian-listed funds, you can now do it for an astoundingly cheap 0.26% a year. All you need is a balanced combination of U.S. equity (VFV), international equity (VEF), emerging-market equity (VEE), a short-term Canadian government bond index (VSB) and a real estate income trust fund (VRE).

These products could shave roughly 20 basis points from what a similarly designed portfolio would have cost just a few years ago. If, for example, you invested $10,000 per year for 30 years, averaging 8.2% instead of 8%, you would save $48,000 in investment costs alone. And if the financial institutions continue to wage a price war, you could benefit further.

The Bank of Montreal and Horizons ETFs, which along with BlackRock’s iShares had much of Canada’s market sewn up, are turning into scrappy contenders in response to Vanguard’s gauntlet. BMO now offers a Canadian equity ETF (ZCN) and a non-hedged U.S. equity index (ZSP), each costing just 0.17%. Toronto-based Horizons has gone a step further with its S&P/TSX 60 (HXT) ETF, charging a miniscule 0.06%. (Note that it holds derivatives rather than actual securities, so the risk is fractionally higher.)

The multi-year price war on U.S.-listed ETFs could be a sign of what’s to come in Canada. Schwab, for example, has challenged Vanguard by offering a broad U.S. market index charging just 0.04% each year. If you’re tempted, however, to wade into the cheaper U.S. market for their ETFs, understand the hidden costs. When converting Canadian dollars to greenbacks, financial institutions hit us with the currency spread. Purchases of less than $10,000 could add a purchasing charge of 1.4%, or less for larger transactions.

In this case, a $10,000 trade charging a $9 commission could cost an additional $140 in hidden exchange rate fees. That isn’t the only downside. Based on the size of your account, your heirs could be liable for U.S. estate taxes upon your death. These phantom costs are another reason for welcoming the ETF price war on the Toronto Stock Exchange, where we can neatly sidestep U.S. estate taxes and currency spreads.

As for those nostalgic gaspump battles? You could see them again in the future. But you don’t have to wait for the ETF price war. It’s here now, and it could save you a heck of a lot more money.

Andrew Hallam is the author of Millionaire Teacher: The Nine Rules of W ealth You Should Have Learned in School