When to transition to owning ETFs and stocks
Thanks to a reader question, I’ll share with you the approach I took to transition out of mutual funds to Exchange Traded Funds (ETFs) and dividend stocks in my investment portfolio.
First up the reader question:
Chris asked My Own Advisor…
“What would be your thoughts on this?
I recall a while ago you mentioned that it would be advisable to move into ETFs and dividend stocks when the portfolio value is larger to mitigate the fees associated with it. Do you know what or when that criteria could be met? I’d like to transition into ETFs or individual stocks but I am unsure how to bridge the gap.”
Thanks for your question Chris, hopefully the information below will give you some insight into my situation, what I did and why I did it so you could this to help make the right decision for your own situation.
When to switch – when to own ETFs and stocks?
In my opinion, there is no absolute right answer regarding how much your investment portfolio must be worth to own Exchange Traded Funds (ETFs) or individual stocks. Your portfolio value could be $1,000, $10,000 or $100,000.
However, based on what I’ve read and the practices I’ve applied in my own portfolio, I think a transition to owning ETFs and individual stocks usually makes sense when you have $10,000 – $25,000 to invest. I believe this is an appropriate value or range because diversification is essential in any well-constructed portfolio and to obtain some diversification, you’ll need to own at least a couple of ETFs or many individual stocks and to get that diversification.
Besides, once you have established an emergency fund I believe it makes sense to invest your money for the long-haul. That’s usually after you have saved up a few months’ worth of an emergency fund.
To sell out of your existing mutual funds or other financial products (if you have them…..) a reminder you might be charged transaction fees to do so. If you’re fortunate not to be paying fees (i.e., deferred sales charges) when selling your mutual funds, you’re likely going to be charged some fees to buy ETFs – so watch out for those.
So, look for commission-free buying of ETFs and brokerages that offer that.
Beyond buying ETFs, account fees can be a portfolio killer because fees often take some time to recuperate from. It’s money you never see again! To avoid paying more fees than necessary, most individual discount brokerage accounts invested with > $15,000 in value will waive all account management fees.
So, look for brokerages that have no account minimums or at least, very low thresholds for account minimums.
In my case, when I switched out of mutual funds into ETFs and dividend paying stocks many years ago, my household assets were at a point where I qualified for $10 transactions and no account fees.
What about owning just stocks?
Owning dividend paying stocks for the long-run is another excellent strategy for wealth creation but based on the diversification reasoning above, it’s hard to achieve with a small portfolio value under $10,000 or even 25,000. Sure, you could own $1,000 of every Canadian bank, a few Canadian telecommunications companies, pipelines, utilities and energy companies as well but it may cost you a bunch of transaction fees to build that portfolio. Even with those companies, you’re still missing out. Canada only represents something like 2-4% of the entire global equity market. Even with all these Canadian stocks in your portfolio, you’re only getting a slice of the portfolio pie; you’ll need to look to the U.S. and beyond for more equity diversification.
Check out my ETFs page for the best low-cost ETFs to own and why. That will set you up in a good diversified direction!
When to transition to owning ETFs and stocks?
If your savings are over $10,000 or closer to $25,000 then I absolutely think it might be time to get investing.
ETFs can be excellent products for every investor. Individual stocks can be a great way to invest for more sophisticated investors who are willing to take on some individual company risk. In the latter case, owning individual stocks, especially those that pay regular dividends, is also a wealth-building strategy but one must be more careful with this strategy over indexing. There are never guarantees in owning any one company no matter how long it has paid dividends.
When to transition from mutual funds to owning ETFs and stocks?
Well, if this applies to you, here are some ideas and reminders:
Mutual funds and exchange-traded funds (ETFs) are two distinct products – so – there is no way to transfer funds directly from one to the other. You must first sell your mutual funds and then purchase ETFs.
Given you may or may not able to purchase ETFs at the same financial institution as you currently hold your mutual funds – you will need to open a self-directed account.
Finally, if you are holding the mutual funds in a registered plan, such as an RRSP, you will not need to pay tax on any capital gains from the mutual funds as long as the funds stay within the plan (i.e., you continue to hold all assets/new ETFs in the same registered plan). If you are moving funds between two financial institutions, the transfer must be made directly by the financial institution to avoid a tax bill. There may be fees associated with the transfer.
Be careful!
Thanks for your readership and your questions!
Mark
@The Dividend Ninja
Be careful Questrade does have an inactivity fee if you don’t make a commissionable trade a quarter. So if you buy only no-fee ETFs you will get charged an inactivity fee unless you are 25 years of age or under or unless you have a 5000 balance. It’s still a brokerage worth considering, though.
I think you can start buying no-load mutual funds as soon as you want. The trick is to buy ones with a very low MER and a broad diversification or a balanced fund. Buying ETFs might require a commission unless you are at Questrade or possibly iTrade so I would agree $25k and up might be the time to start investing in ETFs.
I think the new commission-free ETF innovations make this an almost negligible point Mark. You can open a discount brokerage account and run your own TFSA or RRSP for almost nothing if you’re just dealing in basic bread and butter ETFs. As long as you don’t need to sell (and why would you if you’re just starting out) you can basically do this all commission free. If you need to re-balance your portfolio when you’re small, you can basically do it just by allocating your new additions periodically right?
It’s possible TM, but not everyone is a fan of Questrade or SoctiaItrade. Also, not every ETF is available for commission-free investing. That’s like going to restaurant and only getting part of the menu!
Also, what if you want to own Vanguard US products??
Mark
I figure 30 is decent diversification although far from ideal…I suspect an investor needs about 50+ stocks to have really good diversification whereby no one holding exceeds 5% of portfolio value.
Thoughts?
Thanks for stopping by as always!
Mark, excellent post!
I agree with everything here. I think the ETF and Index core to start is the most sensible approach, and I fully agree with it – only start to invest in stocks when you have the core.
From my expereince I think 25K to 30K is the absolute minimum before you should start buying individual securities. You really need to have 100 shares to get the DRIP benefit, and that doesn’t happen until your at the 50K point IMO. But even with 1K 1.5K purchases you’ll still get the real benefit of dividend income.
You just have to watch your fees though, but with a broker like Questrade at $4.95 per trade, you certainly can buy cost effectively in 1K blocks.
Cheers
The Dividend Ninja
@Eddie
Eddie, Questrade has the most reasonable fees by far compared to any discount broker in Canada. At $4.95 per trade you can’t beat it plus commission free ETFs. I believe they have no admin fees for the RRSP either, and no inactivity fees etc. etc.
You’ll need 25K minimums to avoid the $125 RRSP admin fee each year, with most brokers. As well, if you don’t have 50K with TD you’ll end up paying $29 per trade instead of $9.99.
I’m with TD because I bank with them, but if I was doing it all over again, I would likekly go with Questrade IMO. But they are certainly not 100% and I’ve heard some problems from some. 😉
Cheers
The Dividend Ninja
Great article.
I don’t invest in ETFs yet, but I’ve looked at QuestTrade and their options. Any thoughts? Who do you use? TD E-Series?
Great article. Here’s something that might help someone just starting out.. Questrade has no commissions on purchases on ETFs. That means: stocks, bond funds, stock funds.. any Canadian and American funds traded on an exchange. Very handy. That means someone with very little capital can purchase just one or two shares of each ETF a month and incur no fees. The regular fees for selling still apply. Great for dollar cost averaging.
Hey Adam,
Thanks for this reminder to readers. I didn’t get into too many details in my article but this one is good to share!
I agree with Financial Independence Journey. I invest in $1,000 blocks at a time and am slowly building my dividend growth portfolio. Right now I’m pretty diversified and getting more diversified with each new purchase. Also my trading fees are pretty low if you can find a good online broker. If your not comfortable with individual stocks I’d look into buying index funds. They give you the diversification and average market returns with low fees. As far as money already invested in mutual funds I’d probably keep it in there unless you will face no fees to sell them or if the mutual funds performance isn’t at least matching average market performance.
Great point Dan. I typically invest every $1K myself although sometimes a bit less.
There are really no rules per se, when you must have X $$ to invest in ETFs but my key is….you should try and keep your transaction costs low.
How long have you been investing BTW?
I feel that it’s more a question of education and comfort. Once you’re comfortable trying to invest in individual stocks you can do so by investing in $1,000 blocks. I’m building my dividend growth portfolio over time. When I started, I wasn’t very diversified, now I’m more diversified and still working on it.
You don’t need to necessarily sell out of your mutual funds. You could just stop adding investing in them and transition into stocks as you feel comfortable.