So you are looking to invest in the S&P 500 and there are many options even though there is just one index … Which should you choose becomes the question.
Putting aside all of the different offerings from financial institutions, the focus here will be on the currency option that can be best for you.
Vanguard’s VFV and Vanguard’s VOO are both Vanguard S&P 500 Index exchange-traded funds (ETFs). The most significant difference between the two is the stock exchange platform and the currency used to exchange.
- VFV is offered on the Toronto Stock Exchange in Canadian dollars
- VOO is offered on the New York Stock Exchange in U.S. dollars.
What is the S&P 500?
The Standard & Poor 500 is an index tracked and following guidelines by the S&P Global. In short, the index tracks the largest 500 publicly traded companies on the U.S. stock exchange. For more details on the selection criteria, have a look at the S&P Global guidelines.
The Vanguard S&P 500 Index ETFs, VFV and VOO, both contain the same stocks and aim to replicate the returns as accurately as possible. Therefore, the funds are managed passively to help investors keep fees low.
What Are Index ETFs?
A little primer for those new to index funds. An index fund is an ETF or mutual fund that tries to match a particular market. It contains pieces of multiple companies in a market index.
This means that when you invest, your money gets spread out to multiple companies instead of just having them in one.
However, not all indexes perform the same, due diligence for your investing strategy should be considered in researching the best ETF for your portfolio.
What is Vanguard?
Vanguard was founded in 1975. That same year, they launched the first index fund tracking the S&P 500. They are now the largest issuers of mutual funds and the second-largest of ETFs.
VFV vs VOO: How They Differ
While they both follow the S&P 500, there are small differences to be aware of.
- VOO launched first on September 7, 2010, and VFV launched next on November 2, 2012, two years later.
- VFV simply holds VOO which implies a currency transaction, therefore exposing VFV to currency purchasing power.
- VFV pays the withholding tax of 15% regardless of the account you hold it in. This is simply due to how the ETF is setup.
- VOO has a lower MER of 0.03% while VFV has an MER of 0.09%. Both are low but not the same.
One short way to think about it for the most optimal setup, buy VOO in your RRSP, and VFV everywhere else.
VFV vs VOO: Rate of Return Comparison
While they both track the S&P 500, Vanguard’s VOO does it the most natural way. In fact, it matches the index perfectly. It simply buys the companies with the US currency from investor in US denomination.
For VFV, it’s a different story because currency plays a part. Here is how they perform to date.
As the graph above shows, the returns for both VFV and VOO are relatively similar. But if both ETFs have the same index, why are the returns different?
Let’s broaden the timeline to see why.
Why is VFV doing so much better? Isn’t it a no brainer to just buy VFV? Well, that depends on your view on currency.
If you wre investing in the early 2010, you would remember the USD and CAD dollar was at par for a long time. It happens that VFV came along during that time. You can see that as the USD gained value, so did VFV until 2016 or so. The gap between the two chart is a factor of currency value mostly. You should expect convergence if the CAD dollar gains strength.
Complicated isn’t it? Do you let VFV deal with the currency for you, or do you buy USD and trade VOO. Either way, as a Canadian, the currency plays a role in the end.
Here they are by numbers, and I added VSP which is attempting to manage the currency fluctuation and stay closer to VOO – the real index performance.
There are other factors impacting the peformance as outlined below.
- Differences in Management Expense Ratios (MERs). As of December 31, 2022, the MER for VFV is 0.09%, and for VOO, it is 0.03%. The smaller the MER, the higher the return since it costs less to manage the ETF.
- Difference in dividend yields. As of July 7, 2023, The dividend yield for VFV is 1.28%, and VOO’s is 1.52%.
- Withholding tax on dividends. As Canadians, we are subject to a 15% withholding tax on dividends, reducing the total return. The withholding tax is there because VFV holds the VOO, and under the Canada – U.S. Tax Treaty, U.S. ETFs incur the 15% tax on dividends received from U.S. businesses.
- Fluctuations between the Canadian and U.S. dollar. With VOO, you control your currency exposure but with the other ETFs, it’s done for you.
S&P 500 Constituents – What does the ETF holds
The underlying holdings are similar since VFV and VOO track the S&P 500 Index. Therefore, you will be exposed to over 500 stocks.
The difference, however, is in their structures.
VOO purchases each stock individually, making up the S&P 500 Index based on its exact weighting. For VFV, it purchases VOO directly rather than buying each stock separately.
According to Vanguard at the time of writing the Sector Weightings (%) of the S&P 500 is as follow.
VOO’s top 10 holdings (30.35% of total assets) are outline below – numbers as of the time of writing.
|Alphabet Inc Class A||GOOGL|
|Alphabet Inc Class C||GOOG|
|Meta Platforms Inc Class A||META|
|Berkshire Hathaway Inc Class B||BRK.B|
|UnitedHealth Group Inc||UNH|
VFV vs VOO: Tax Efficiency
As mentioned, a 15% withholding tax applies to all dividends received through the ETFs. For VFV, this applies to both non-registered and registered accounts. Because of this high withholding tax, you may notice a decreased amount in your returns.
The 15% withholding tax applies to the VOO, but only if the shares are held in a TFSA or non-registered account. You will not have to pay this tax if your VOO stock is in an RRSP.
Impact of Withholding Taxes
Whether you are an individual or a fund, withholding tax is often imposed on dividends paid to foreign investors. When determining the costs of the withholding tax and its impact on your return, there are a few essential factors to consider.
- Underlying Holdings
- Structure of the ETF
- Type of investment account in which the ETF is held
Depending on these factors, investors could be subject to two levels of withholding tax.
- Level 1 – Withholding taxes apply to U.S.-listed ETFs to Canadian investors. Taxes will be applied when the U.S.-listed ETF pays out a dividend.
- Level 2 – Withholding taxes are applicable when U.S. ETFs are held indirectly through a Canadian-listed ETF. The U.S.-listed ETF withholds 15% of the dividend.
In addition, withholding taxes differ based on the type of investment account that holds the ETF. Namely, all the accounts available have rules around tax considerations. Certain withholding taxes are exempt for RRSP accounts if the underlying U.S. securities are held directly. You can use tax credits to recover some of the incurred withholding taxes for taxable accounts in some instances.
|TFSA||Level 2||Level 1|
|Taxable||Level 2||Level 1|
|RESP||Level 2||Level 1|
|FHSA||Level 2||Level 1|
In short, you cannot avoid the US withholding tax with Vanguard’s VFV.
VOO vs VFV: Currency Impact
To recap, VFV is a Canadian ETF holding a U.S. ETF. Therefore, it is subject to currency fluctuations.
VFV is unhedged, meaning it is not protected against loss due to Canadian and U.S. dollar fluctuations. So your total return will always be impacted by the exchange rate between the USD and the Canadian dollar.
If CAD appreciates, you lose value. If CAD depreciates, you gain value. Since inception, the CAD has lost value leading to a higher total return.
VOO is slightly different since it trades in U.S. dollars already; currency fluctuations do not impact your returns. However, if you convert your return into Canadian dollars, you will be subject to currency fluctuations.
Should you buy VFV or VOO?
Which should you invest in? Well, that depends.
The lower MER and higher dividend yield of VOO are enticing but remember you will be subject to the currency conversion one day … if not just to calculate taxes for the Canadian government. You can also hold VOO in your RRSP, where you will not be subject to the withholding tax on the dividend for higher efficiency.
However, some of us like to invest consistently and clearly, so VFV might be the most straightforward option since everything is already in Canadian dollars.
Without overthinking the details, go with Vanguard’s VFV for simplicity. Holding VOO is only for your RRSP and only if you are comfortable with the potential USD fluctuation.