Last week, Vanguard Canada announced the management fees and ticker symbols for its initial line-up of six Exchange-Traded Funds (ETFs). Staying true to its low-cost philosophy, Vanguard priced the ETFs cheaper than existing comparable products. While I’m very excited about the lower fees charged by Vanguard ETFs I think that any decision to switch out of existing ETFs should be made on a case-by-case basis. For instance, the management fee charged by the Vanguard MSCI Canada Index ETF (TSX: VCE) is about 6 basis points or so less than the iShares S&P/TSX 60 ETF (TSX: XIU). As Michael James pointed out in a recent post, if you own $10,000 worth of XIU, switching to VCE will save you just $6 per year. For investors paying $30 per trade, the tiny savings may not be worth the bother.

So, how do you decide whether you want to switch from an existing ETF into a new product? Here are some factors to consider:

1. Do you hold the investment in a registered account or a taxable account? In taxable accounts, if the adjusted cost basis of your investment is less than its current value, you may be liable for taxes on capital gains. It probably won’t make much sense to pay capital gains to save a few basis points in management fees. But you could decide to channel future savings into the lower cost ETFs and if markets take a steep dive, you could switch out of current holdings and if things get really bad, you may even be able to trigger capital losses.

2. In registered accounts, the math is straightforward. Let’s say that if you save $100 per year in fees, it will be worth your while to switch. The Vanguard Short-Term Bond ETF (TSX: VSB) costs 10 basis points less than the iShares DEX Short-Term Bond ETF (TSX: XSB). If you hold $100,000 worth of XSB in a registered account, switching to VSB will save you about $100 per year. However, keep in mind that you’ll be paying two trading commissions and bid-ask spreads when selling one ETF and buying another. You can knock down the number of trades to one by switching during a rebalancing event but switching will still cost you one trading commission plus bid-ask spreads. If it will take many years for the savings in management fees to make up for the upfront trading costs, it may not be worth your while to switch ETFs.

3. Investors should pay close attention to the bid-ask spreads of the new Vanguard ETFs. Even if volume is low, there may be enough bids and asks to execute your trades at a tight spread. In other words, it is tight bid-ask spreads, not volume that matters when trading ETFs.

4. If you do decide to switch to Vanguard ETFs upon launch, you are making a bit of a leap of faith that Vanguard will be able to keep tracking errors low. I think Vanguard ETFs will be successful in tracking their indexes closely but you are not paying too much in extra fees if you do decide to wait-and-watch.

This article has 11 comments

  1. People who make a living from trading activity must cringe when they read an article like yours that focuses on minimizing frictional costs. I love it. Thanks for the link.

  2. Any thoughts if there is a risk of triggering the superficial loss rule when selling your existing EFT and purchasing a Vanguard ETF? That is by acquiring the “same or identical” property within 30 days? For example, I expect the answer is no for selling XIU for VCE since they track different Cdn indexes but not sure it is as clear in all cases.

  3. Horizon also has one ultra-low MER of .07% on its TSX 60 fund.

  4. @Michael James: Agree. I’m cheap when it comes to trading commissions. And research shows that, on average, the less one trades, the better one’s returns.

    @Michael: I would think that VCE and XIU will not fall under superficial loss rules. Also, I would argue that XSP is different from VUS because they track different indexes and the holdings are different. They track different indexes and their holdings are different. Same argument for the bond funds. It may be more difficult to make the same case for XIN and VEF since both track the MSCI EAFE Index. Likewise for XEM/CWO and VEE.

    @Dale: Yes, Horizons HXT is an interesting product. My intention with XIU was to hold it for a long long long time in a taxable account. Though I find HXT’s tax advantages very appealing, I’m not comfortable with the fund’s swap structure.

  5. @ CC I am neither too old or too proud to learn. Pls better expain HXT’s “swap structure” and why it is that you are not comfortable with it.

    @ MJ PLs explain the nature of your Schadenfreude. I am confused.

  6. @CC I have learned something, thank you. Do other ETFs do this swap thing?

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  9. Would there not be beta slippage if the money is switched over ?

  10. Hi, i am wondering if its prudent to invest in vangaurd etf’s or is it safe to wait for a while?