Q: I have RESPs for my two kids who are seven and 11. I am currently investing in actively managed TD mutual funds and am considering moving to index funds. However, after doing some research, I came across ETFs. I’m wondering which is better for RESPs: ETFs or index mutual funds?
— Catherine O., Calgary
A: ETFs certainly get most of the good press these days, Catherine. And there’s no question they have the lowest management fees around: you can build a diversified portfolio of ETFs for well under 0.20%. Compare that with many actively managed mutual funds with fees 10 times higher.
Index mutual funds are generally more expensive than ETFs, though the TD e-Series funds are still excellent value, with MERs between 0.33% and 0.51%. These funds are only available to TD clients, unfortunately. But since you mention you’re currently using active TD funds, perhaps this is where you hold your RESP.
While ETFs have lower management fees, they are not ideal for smaller accounts, and RESPs usually fall into that category. That’s because most brokerages charge commissions to buy and sell them: $10 is typical, though some brokerages have lower rates, and a few even offer free ETF trading. When your account balance is small, trading commissions can easily make ETFs more costly than index mutual funds, which can be bought and sold for free.
For example, let’s say your RESP is $30,000. A portfolio of ETFs might carry an annual fee of 0.20%, whereas an index fund portfolio might cost 0.45%. In dollar terms, the difference works out to $75 per year. If you were to make eight trades a year and pay $10 for each one, the index mutual funds would actually be cheaper overall.
If you tend to make just one lump sum addition to the RESP each year, the ETFs might be the way to go. But if you make regular monthly contributions, then it will almost certainly be more cost-efficient to use index mutual funds. You can automate those monthly contributions with mutual funds, something that isn’t possible with ETFs.
Finally, using ETFs is significantly more challenging for an inexperienced investor. Placing a mutual fund order is straightforward and can be done at any time. But with ETFs, you need to trade during market hours and be familiar with the correct way to place trades on an exchange, which is intimidating for novices. If you prefer to keep your life simple, index mutual funds are a better choice, even if they’re not the absolute cheapest option.
MORE FROM AN INVESTMENT EXPERT:
- Should you sell mutual funds with DSC charges?
- Pros and cons of a one-ETF portfolio
- Investments to use for a down payment on a house
- Best low-fee U.S. index funds to invest in now
The post ETF or index mutual fund—which is best for an RESP? appeared first on MoneySense.