Switch from Mutual Funds to ETFs: A Practical Guide

Are you thinking about moving your investments from mutual funds to exchange-traded funds (ETFs)? You’re far from alone. Canadian investors have been shifting assets into ETFs: September 2022 statistics from the Investment Funds Institute of Canada showed year-to-date net redemptions of mutual funds of about $18.6 billion, while ETFs saw net purchases of roughly $20.8 billion. That trend reflects growing awareness of cost differences, a wider range of ETF choices, and easier access provided by major financial institutions.

Why investors are switching: costs, choice and access

Three main forces are driving the migration from mutual funds to ETFs. First, many investors now understand that high ongoing costs in some mutual funds can dramatically reduce long-term returns. For example, an equity mutual fund with a 2% management expense ratio (MER) earning a 6% average annual pre-fee return will deliver substantially less to investors after 30 years than a low-cost index ETF charging around 0.20% in MER. Small differences in fees compound over decades and can meaningfully erode retirement savings.

Second, the ETF market has expanded rapidly. There are more sponsors and far more ETF products than in the past, including a large number of low-cost index funds and diversified “all-in-one” ETFs that bundle broad stock and bond exposure into a single fund with target allocations such as 80/20, 60/40, 40/60 or 20/80.

Third, the same major banks and financial firms that long dominated the mutual fund industry are now major ETF providers and operate the online trading and advisory platforms that make buying ETFs straightforward for everyday investors.

Most index funds are ETFs, but many ETFs are not index funds

There’s a common misconception that all ETFs are cheap index trackers. While the largest, most liquid ETFs are indeed passive funds that track broad stock or bond indexes (for example, the S&P 500 or a Canadian bond index), the ETF universe also includes many higher-cost, niche or actively managed products. Sector-specific ETFs—focused on commodities, cannabis, crypto or other narrow themes—can carry significantly higher fees and different risk profiles than broad index ETFs.

Likewise, there are low-cost index mutual funds available, but on average ETFs tend to be cheaper than passive index mutual funds, and both are typically much cheaper than actively managed mutual funds. The key takeaway is that you should evaluate each product on fee structure, strategy and suitability rather than assuming all ETFs or all mutual funds are the same.

ETFs: with or without advice?

Before switching, decide whether you want ongoing financial advice and, if so, what kind. Your choice will influence how you move assets and the total cost of managing your portfolio.

If your portfolio is several hundred thousand dollars or more, a full-service advisor can provide a comprehensive planning process—assessing your situation, recommending an asset mix, providing ongoing guidance, and implementing investments in ETFs. Such advisors typically charge an annual fee of around 1% to 1.5% in addition to ETF MERs, though some advisors offer lower rates for very large portfolios.

For smaller portfolios or investors comfortable with automated solutions, robo-advisors offer diversified ETF portfolios with lower management fees, commonly in the 0.25%–0.50% range on top of ETF MERs. This approach can reduce costs by 0.5% to 1.25% compared with full-service advice, though it provides less personalized human interaction.

If you have a solid grasp of investing basics and at least about $25,000 to invest, you can build and manage your own ETF portfolio through an online discount broker. Long-term buy-and-hold investors who manage their own portfolios will typically pay only ETF MERs as their main ongoing cost. Many brokers offer practice or demo accounts, which are useful for learning before committing real money.

Even do-it-yourself investors can benefit from standalone professional planning. Fee-for-service financial planners provide advice on retirement, tax and estate planning without selling financial products, avoiding conflicts of interest that can arise when advisers receive commissions. Supplementing a DIY or robo approach with occasional fee-for-service planning can be a cost-effective way to get targeted professional help.

Unless your current advisor already offers ETFs or you already have an online brokerage account, switching will require opening accounts with a new firm. Carefully compare brokers and robo-advisors for features, pricing and available account types. When you move registered accounts—RRSPs, TFSAs, RESPs—be sure to transfer each account to the matching registered account at the receiving firm to preserve tax-advantaged status and avoid contribution issues.

You can transfer assets either as a cash transfer, where positions are sold and cash is moved, or as an in-kind transfer, where holdings move as-is into the new account. Cash transfers are sometimes required by robo-advisors that immediately allocate funds into their portfolios; in-kind transfers avoid the risk of sitting in cash and potentially missing market gains, and can defer capital gains tax in non-registered accounts if you retain the positions.

Keep in mind that moving assets can trigger transfer fees charged by the departing firm, and selling certain mutual funds—like Deferred Sales Charge (DSC) funds—may incur penalties. Many investors find that long-term savings from lower MERs outweigh one-time transfer costs or penalties, but you should calculate the net benefit for your situation.

Building a simple, low-cost ETF portfolio

Whether you opt for a full-service advisor, a robo-advisor, or a DIY approach, a straightforward, diversified ETF portfolio can be built efficiently. If you are doing it yourself, follow these steps:

• Define your asset allocation: decide the mix of stocks versus fixed income (bonds/GICs) that matches your goals, time horizon and risk tolerance. This decision has the greatest impact on long-term returns and volatility.
• Decide geographic exposure: include Canadian, U.S. and global equities to achieve adequate diversification. Because the Canadian market is relatively small, non-Canadian exposure is often necessary for broad diversification.
• Choose fund styles: select between passive index ETFs, all-in-one blended ETFs, or actively managed ETFs based on cost, convenience and your investment beliefs.
• Select specific ETFs: review provider materials and industry listings to compare MERs, liquidity, tracking error and fund structure when picking funds.
• Rebalance when needed: periodically adjust holdings if market movements cause your allocation to drift significantly from your target; all-in-one ETFs handle this automatically.
• Review asset allocation over time: as your circumstances and goals change, update your allocation accordingly.
• Consider tax impacts: account type and fund location (registered vs. non-registered) affect tax efficiency and should influence your choices.

In many cases, a diversified portfolio can be constructed with just three to four ETFs—or even a single, well-chosen all-in-one ETF. Before making any moves, take time to learn core investment concepts and run through potential scenarios so you understand the trade-offs. As Warren Buffett put it, “The best investment you can make is in yourself.”

Larry Bates is the author of Beat the Bank: The Canadian Guide to Simply Successful Investing and is an investment advisor with Aligned Capital Partners Inc.

Read more on investing:

• How to choose ETFs for your investment portfolio
• ETFs aren’t just for passive investing anymore
• How to start investing with ETFs in your 20s
• How to use ETFs in your child’s RESP