When to buy U.S.-listed ETFs

Q: Under what specific circumstances would it be better to hold a U.S.-listed ETF if there is a Canadian equivalent? For example, when it is preferable to use the Vanguard Total Stock Market (VTI) rather than the Vanguard U.S. Total Market (VUN)? — R. F.

Until late 2012, there really were no great options for Canadian ETFs that held U.S. and international equities. If you wanted a low-cost, cap-weighted index fund that did not use currency hedging, you were out of luck. That’s why my Complete Couch Potato model portfolio currently uses a pair of U.S.-listed ETFs for its foreign equity components.

But the case for using U.S.-listed ETFs is not nearly as compelling as it used to be. Since April, iShares and Vanguard have launched inexpensive Canadian ETFs covering the broad U.S. and international markets without currency hedging. For example, the Vanguard U.S. Total Market (VUN), launched in August, is virtually identical to the Vanguard Total Stock Market (VTI)—indeed, VUN simply holds units of VTI.

There are three important differences between these ETFs, however:

• VUN has a higher management fee: 0.15% compared with just 0.05% for VTI
• VTI trades in US dollars, which may result in investors incurring significant currency conversion costs
• VTI is exempt from the 15% US withholding taxes on dividends if it is held in an RRSP

VUN has the edge in taxable accounts and TFSAs

In my opinion, VUN should be the default choice if you’re holding U.S. equities in a non-registered account or a TFSA. In these two account types, neither fund has any tax advantage: both ETFs are subject to the withholding tax on dividends. In a non-registered account, the tax is recoverable by claiming the foreign tax credit, while in a TFSA it cannot be recovered.

That means the only issues to consider in a taxable account or TFSA are the differences in management fees and the cost of converting currency. And in most cases, the foreign exchange costs will have a higher impact.

VUN’s additional management fee of 0.10% (the full MER will likely be a couple of basis points higher) amounts to just $10 on every $10,000 invested. That’s peanuts. If the alternative is paying your brokerage’s normal currency conversion rates (which may be upwards of 1.5%, or $150 on $10,000), then VUN is a no-brainer. Even if you’re comfortable doing Norbert’s gambit, remember this typically involves two $10 commissions and a small spread, so do the math and ask yourself whether it’s really worth it. It probably isn’t unless the transaction is very large.

VTI makes more sense in an RRSP

If you’re holding U.S. equities in an RRSP, then it’s worth taking a closer look at VTI. With the yield on U.S. stocks now at about 2%, the withholding tax represents an additional drag of about 0.30% for VUN. So now the total cost difference—including both the higher MER and the withholding tax—is more like 0.40%.

At that point it’s worth at least considering using Norbert’s gambit to convert your loonies to US dollars in order to purchase VTI. Again, however, the size of the transaction is important. Norbert’s gambit is usually not efficient unless you’re exchanging five-figure sums, so if you’re contributing a few thousand dollars a year to U.S. equities, VUN is likely to be the less expensive option even in an RRSP.

And if you are willing to pay a little extra for the convenience of making all your trades in Canadian dollars (and there’s nothing wrong with that), VUN is likely the most appropriate choice in any type of account.