Monday, November 12, 2007

Index Fund Examples

Low-cost index funds are a great way to own a very broad range of stocks without paying high fees. Of the many index funds to choose from, two are described in the table below. If some of the table entries don’t mean much to you, don’t worry because I’ll explain them.

CountryU.S.Canada
Fund NameVanguard Total Stock MarketiShares Canadian Large Cap 60 Index
Stock TickerVTIXIU
Description1200 largest U.S. public companies60 of the largest Canadian companies
MER0.07%0.17%
MER251.7%4.2%

These two mutual funds are called Exchange-Traded Funds (ETFs) meaning that they can be bought and sold like stocks in the stock market. Other mutual funds are bought directly from the mutual fund company or through an intermediary like a financial advisor who deals with the fund company. The stock ticker listed in the table above is the symbol that is used to identify the stock (or ETF) when making a buy or sell order.

Low MER

An important attribute of these funds is that they have very low Management Expense Ratios (MERs). Calculating the expense ratio over 25 years, which I abbreviate MER25 in the table, gives a better idea of how low the fees are with these funds. A typical mutual fund in the U.S. might have an MER of 1%. After 25 years, this eats up 22% of your money, but the Vanguard Total Stock Market Fund only takes 1.7% of your money after 25 years. A typical Canadian fund is closer to a 2% MER, which corresponds to a 40% MER25, compared to only 4.2% after 25 years with the iShares Canadian Large Cap 60 Index Fund.

If you haven’t heard of these funds before, it might be because your financial advisor makes his money from commissions, and these funds don’t pay any commissions. Beware of funds that are called index funds, but charge high commissions anyway. By definition, index funds don’t require a manager who makes decisions about which stocks to buy, and charging high management expenses cannot be justified.

Low Taxes

There are experts who decide which companies belong in a given index, and these experts make infrequent changes as necessary. A low rate of change means that the fund does not often buy or sell stocks. This is important for investments that are not tax-sheltered in an IRA (U.S.) or an RRSP (Canada). Less change means lower capital gains taxes that investors have to pay each year that they own the fund. However, these index funds are fine for tax-sheltered accounts as well.

In the next post, I will discuss how to go about investing in index funds for those who have not worked without a financial advisor.

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