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ETF vs. mutual fund in Canada

ETF vs. mutual fund in Canada | Where to place your investment dollars

Noel Moffatt

By Noel Moffatt

🗓️

Updated: September 27, 2024

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When deciding where to invest your hard-earned dollars in Canada, the choice between Exchange-Traded Funds (ETFs) and mutual funds often comes up. 

Both investment options pool money into diversified portfolios of stocks, bonds or other assets, but they differ in flexibility, costs and management styles. The right choice depends on your financial goals, investment style and how much involvement you want in managing your portfolio.

Key takeaways

  • ETFs offer real-time trading flexibility and typically have lower expense ratios compared to mutual funds, making them ideal for cost-conscious investors seeking active management
  • Mutual funds provide the benefit of professional management and potential for better long-term performance due to their actively managed nature, though they usually come with higher fees and tax liabilities
  • When choosing between ETFs and mutual funds, consider trading flexibility, cost and tax implications based on your investment objectives and personal financial situation

Let’s break down the advantages and drawbacks of each option to help you make the best decision for your investment strategy.

Read more: Best ETFs in Canada

Advantages of ETFs vs. mutual funds

ETFs offer several distinct advantages over mutual funds, making them a popular choice for both beginners and experienced investors:

  1. 1.

    Lower fees: One of the standout benefits of ETFs is their lower fees. Many ETFs are passively managed, which helps reduce costs, unlike the active management often required for mutual funds.

  2. 2.

    Tax efficiency: ETFs tend to be more tax-efficient due to their structure. Because ETFs are traded on exchanges like stocks, they are less likely to trigger capital gains taxes until you sell your shares. In contrast, mutual funds regularly buy and sell assets within the fund, often resulting in taxable capital gains for investors.

  3. 3.

    Intraday trading flexibility: ETFs are traded throughout the day, offering real-time pricing. This allows investors to react quickly to market changes, which is particularly useful for day traders or those who like to manage their portfolios more actively. Mutual funds, however, only trade at the end of the day based on the Net Asset Value (NAV).

  4. 4.

    Transparency: ETFs often provide greater transparency, with many disclosing their full holdings on a daily basis. Investors can see exactly what they are buying into, while mutual funds may only report their holdings quarterly.

  5. 5.

    Diversification: Like mutual funds, ETFs offer instant diversification by holding a broad array of assets. Whether you’re investing in a sector, commodity, or market index, ETFs allow you to access diversified portfolios without the need to buy individual stocks or bonds.

Benefits of mutual funds vs. ETFs

While ETFs have many advantages, mutual funds offer their own set of benefits that appeal to certain types of investors:

  1. 1.

    Active management: Mutual funds often come with professional management, which can be appealing if you prefer to leave your investments in the hands of experienced professionals. Fund managers actively adjust the portfolio based on market conditions, potentially outperforming passive index strategies.

  2. 2.

    Automatic reinvestment: Mutual funds offer the convenience of automatic reinvestment for dividends and distributions, which helps grow your investment over time without the need for manual intervention. In contrast, ETFs typically require you to reinvest distributions manually unless your broker offers an automatic reinvestment program.

  3. 3.

    No trading requirements: Unlike ETFs, which require you to have a brokerage account and trade during market hours, mutual funds are simpler to manage. They don’t require daily monitoring, making them ideal for investors who prefer a “set it and forget it” approach.

  4. 4.

    Variety of fund types: Mutual funds offer a wider variety of fund types, including bond funds, equity funds, balanced fund and target-date funds, catering to different investment goals and risk profiles.

  5. 5.

    Low entry costs: Many mutual funds allow for low minimum investments, making them accessible for new investors who may not have significant capital upfront. ETFs, though accessible, still require investors to purchase at least one share, which may be costly depending on the ETF price.

Summary

In summary, ETFs provide lower fees, better tax efficiency, intraday trading flexibility and greater transparency, making them a great option for cost-conscious, self-directed investors who prefer control over their trades. 

Mutual funds, on the other hand, offer the benefit of professional active management, automatic reinvestment and lower entry costs, making them more ideal for hands-off investors willing to pay higher fees for expert management. 

Cost of ETFs vs. mutual funds

Costs are a critical factor when choosing between ETFs and mutual funds. Let’s compare the cost of buying two popular, similar ETFs and mutual funds in Canada.

For this comparison, we’ll look at iShares Core S&P/TSX Capped Composite Index ETF (XIC)1, a popular ETF tracking the Canadian stock market, and RBC Canadian Equity Fund2 , a comparable mutual fund.

ETF (XIC):

  • MER: 0.06%
  • Trading commission: $4.95 to $9.95 (depending on your platform)
  • No minimum investment

Mutual fund (RBC Canadian Equity Fund):

  • MER: 2.16%
  • No trading commissions (if bought directly through RBC)
  • Minimum investment: $500

Winner: ETFs come out on top in terms of cost efficiency due to lower MERs and the absence of ongoing fees, like trailing commissions. Mutual funds often carry higher fees due to active management, which can significantly eat into long-term returns.

To truly understand how fees affect your investments over time, I recommend using an interactive fee impact calculator3 to see how much you could save by choosing lower-fee investment options.

ETF fees vs.mutual fund fees

When looking at fees, the Management Expense Ratio (MER) is just the beginning. Let’s dive into other fees that can affect your overall investment costs:

  • ETFs: ETFs generally have lower MERs due to their passive nature, and trading commissions may apply each time you buy or sell shares. These fees depend on your brokerage platform, but many now offer commission-free ETF trades (we break these down later)
  • Mutual funds: In addition to MERs, mutual funds may charge sales loads or redemption fees, particularly if sold within a certain period. Many also have trailing commissions (recently removed for self-directed accounts), which are ongoing fees paid to advisors

Winner: ETFs have the edge with lower overall fees, particularly for cost-conscious investors looking for efficient, passive investment vehicles.

Related Article: Management Fee vs. MER

ETFs vs. mutual funds for performance

Performance is where things get interesting. ETFs generally aim to track the performance of a particular index, such as the S&P/TSX Composite Index4 or S&P 500, meaning their returns are closely aligned with market averages. 

Mutual funds, on the other hand, have the potential to outperform the market, thanks to active management.

Let’s compare the performance of two similar funds over a five-year period:

  • ETF (XIC): Tracks the S&P/TSX Composite Index and provides returns that mirror the overall Canadian market. Over the past five years, it delivered an average annual return of around 7%, with lower fees contributing to a more consistent net return
  • Mutual fund (RBC Canadian Equity Fund): Actively managed, this fund seeks to outperform the market. It posted an average annual return of around 6.5% over the same period, but with significantly higher fees (MER of 2.16%), the net return for investors ends up being lower than the ETF’s return
Comparing ETF vs. Mutual fund performance ETF (XIC) Mutual fund (RBC Canadian Equity Fund)
Fund objective Tracks S&P/TSX Composite Index Actively managed
5-year average annual return 7% 6.50%
Management Expense Ratio (MER) 0.06% 2.16%
Net return after fees ~6.94% ~4.34%
Performance notes Lower fees, consistent net return Higher fees, potential to outperform but erodes gains
Results after 20 years of a single $10,000 investment $38,265 $23,389

If we dive even deeper into the long-term impact of fees on investment returns and assume an initial investment of $10,000, the difference in MER between an ETF with 0.06% and a mutual fund with 2.16% could result in a discrepancy of nearly $15,000 in potential earnings over 20 years. 

Long story short, it's crucial to consider fees as a central factor in your investment strategy.

Winner: ETFs win on net performance, especially over the long term. While mutual funds may outperform in certain periods, the higher fees can erode gains, making ETFs a more cost-effective choice for passive investors.

ETFs vs. mutual funds for long term investments

Long-term investors often prioritize factors like fees, tax efficiency and potential growth when choosing between ETFs and mutual funds.

  1. 1.

    ETFs for the long-term: With lower MERs and greater tax efficiency, ETFs are well-suited for long-term, buy-and-hold strategies. Since they generally track an index, they provide steady returns that grow with the market. The ability to avoid capital gains taxes until you sell shares makes them a tax-friendly option for long-term investors.

  2. 2.

    Mutual funds for the long-term: Mutual funds offer the advantage of professional management, which could result in higher returns during market downturns. Additionally, they provide the convenience of automatic reinvestment for dividends and capital gains, helping your investments grow without manual effort. However, the higher fees and frequent trading within the fund make them less tax-efficient than ETFs.

Winner: ETFs are generally more suitable for long-term investors due to their lower fees and tax efficiency. Mutual funds may offer the advantage of active management, but over time, the higher fees can outweigh the potential benefits.

ETFs vs. mutual funds for risk

Risk is a key consideration for every investor, and ETFs and mutual funds offer different risk profiles depending on how they are managed.

  1. 1.

    ETF risk: Because ETFs track market indexes, they are exposed to the same volatility as the broader market. If the market drops, so will the ETF’s value. However, ETFs offer diversification, which helps reduce the impact of individual stock performance on your portfolio.

  2. 2.

    Mutual fund risk: Mutual funds carry both market risk and management risk. While active management can help navigate downturns, it also introduces the possibility of poor decision-making by fund managers. With that being said, mutual funds offer a range of risk profiles, from conservative bond funds to aggressive equity funds, allowing investors to choose a fund that matches their risk tolerance.

Winner: It’s a tie. Both ETFs and mutual funds can be tailored to match an investor’s risk tolerance. If you prefer passive investment with market-mirroring risks, ETFs are the way to go. If you value the potential for active management to mitigate risk, a mutual fund may be a better fit.

ETFs vs. mutual funds for tax efficiency

Tax efficiency is another major factor when choosing between ETFs and mutual funds, especially in taxable accounts.

  1. 1.

    ETF tax efficiency: ETFs are generally more tax-efficient because of their structure. You only pay capital gains taxes when you sell your shares, not when the ETF buys or sells individual assets within the fund. This means fewer taxable events and lower tax bills, especially for long-term investors.

  2. 2.

    Mutual fund tax efficiency: Mutual funds tend to be less tax-efficient because they regularly buy and sell assets within the fund, creating taxable events even if you don’t sell your shares. If the mutual fund sells a stock at a gain, you could be hit with a capital gains tax, even if you didn’t personally sell anything.

Winner: ETFs are more tax-efficient, making them a better choice for investors who want to minimize taxes on their investments.

ETF vs. mutual funds pros and cons

Here’s a quick summary of the pros and cons of ETFs vs. mutual funds:

Buying and selling ETFs

Pros

Pros

  • Lower fees (MERs)

  • Real-time trading flexibility

  • Greater tax efficiency

  • Transparency of holdings

  • No minimum investment

Cons

Cons

  • Requires active management by the investor

  • Dividends may not be automatically reinvested

  • Market volatility can affect value

Buying and selling mutual funds

Pros

Pros

  • Professional active management

  • Automatic reinvestment of dividends

  • Wide variety of fund types (bonds, balanced, equity)

  • No need for frequent trading

Cons

Cons

  • Higher fees (MERs, sales loads)

  • Less tax-efficient

  • Trades only once per day (no real-time trading)

  • Minimum investment requirements

How to buy ETFs and mutual funds

Now that you have a solid understanding of the differences between ETFs and mutual funds, let’s look at how to purchase them. Here are some of the top platforms in Canada for buying ETFs and mutual funds:

Questrade Wealthsimple CIBC Investor's Edge
Questrade logo Wealthsimple logo CIBC Investor's edge logo
Best for: Active traders and those looking to buy ETFs without paying commission fees Best for: Hands-off investors who want automated portfolio management through robo-advisors Best for: Investors who prefer traditional banks and want access to both ETFs and mutual funds
• Fees: Free to buy ETFs, $4.95 to sell • Fees: Management fees start at 0.50%, which includes ETF management fees • Fees: $6.95 per trade for ETFs, no load fees for mutual funds
Questrade allows you to build a diversified portfolio of ETFs without paying for buying transactions. It’s ideal for cost-conscious investors looking for low fees and a variety of investment options. Wealthsimple makes it easy to invest in a diversified portfolio of ETFs without needing to actively manage it yourself. It’s a great option for beginners who want a simple, automated investment solution. For those who prefer banking with CIBC, this platform offers access to a wide range of ETFs and mutual funds, with competitive fees for both types of investments.
Questrade review Wealthsimple review CIBC Investor's Edge review
Buy ETFs for less Let a robot do the work Buy ETFs and mutual funds
Noel Moffatt Writer

Noel Moffatt is a Canadian fintech expert with a passion for simplifying personal finance. Based in St. John’s, NL, he draws on his background in finance, SEO, and writing to deliver clear explanations and actionable advice. Noel is dedicated to equipping readers with the knowledge and tools they need to make informed financial decisions, striving to make personal finance more accessible and understandable through his in-depth articles and reviews.

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