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There is a right way to be an index investor, and a more expensive wrong way.

The right way is through exchange-traded funds, which have management-expense ratios as low as 0.06 per cent or so for funds that track the S&P/TSX Composite Index. That’s darn close to zero.

The wrong way is through the index mutual funds sold by the big banks. As a rule, these funds range from notably to egregiously overpriced. A quick example: The CIBC Canadian Index Fund Class A, with an MER of 1.14 per cent.

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A warning about bank index funds is necessary because there is a significant amount of money invested in them. CIBC Canadian Index has about $567-million in assets, while RBC Canadian Index Series A has $718-million and the various versions of TD Canadian Index have $1.4-billion. The Scotia Canadian Index Fund has a total of roughly $250-million and the BMO Canadian Equity ETF Fund is around $320-million. (Note: this mutual fund holds a Canadian-index ETF.)

All of these funds offer a few strong advantages over ETFs. You can buy and sell them at no cost, you can open an account with as little as $100 to $500, and subsequent investments can be as low as $25. But the comparatively high fees of these funds make them a weak substitute for ETFs.

It’s true that you generally have to pay brokerage commissions to buy and sell ETFs – figure on roughly $10 a go. But the lower MERs more than compensate. Let’s assume the S&P/TSX Composite delivers an annualized total return over 10 years of 7 per cent. An ETF with a fee of 0.06 per cent would ideally deliver a net gain of 6.94 per cent, while an index fund with an MER of, say, 0.9 per cent, would give you 6.1 per cent. After 10 years, on an initial investment of $1,000, the index fund would give you $1,808 and the ETF would give you $1,956.

One exception to the high fees of bank index funds is the e-series from Toronto-Dominion Bank. TD Canadian Index – e has an MER of 0.33 per cent, comparatively cheap for its peer group. It’s a better choice than other index funds, but the fees are still higher than ETFs.

About that BMO Canadian Equity ETF Fund: It holds the BMO S&P/TSX Capped Composite Index ETF (ZCN), with an MER of 0.06 per cent. Buy the ETF, not the index fund that holds it.

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