WHAT EVERY INVESTOR NEEDS TO KNOW ABOUT ETFS
Exchange Traded Funds, known as ETFs, are a popular investment choice for investors because they are typically easy to use and simple to understand. Whether you’re new to investing or have been at it for years, there is likely an ETF that’s right for your portfolio.
WHAT IS AN ETF
An ETF is an exchange traded fund. It’s an investment product that is sometimes compared to a mutual fund because both products offer instant diversification, but how they are managed and used in a portfolio can vary.
An index ETF holds a basket of stocks, bonds, or securities that track an underlying index. The securities held within an index ETF reflect the makeup of the index it is tracking. For example, the most popular index in Canada is the S&P TSX 60. Any ETF tied to this index will hold or provide exposure to the same proportion of the stocks that make up that index. This transparency is one of the greatest features of an index ETF because it is easy for an investor to optimally diversify when they know exactly what they are getting exposure to within the ETF.
Since ETFs are cost-effective and easy to trade, they are used by the largest institutions and pension fund managers in the world and are quickly becoming a popular choice for everyday investors. In July 2020, there were over 800 ETFs for Canadians to choose from, with over $217 billion in assets managed (Source: CETFA Monthly Report, June 2020)
HOW DO ETFS WORK?
Most ETFs are passively managed, which means they aim to match the performance of a certain index, but do not try to outperform it. Mutual funds, on the other hand, are typically actively managed and try to beat the market. They require a large team of analysts to research the securities and actively buy and sell to attempt to deliver gains for the fund.
A passive investment strategy means that the ETF will perform the same way the index performs. As a result, passive ETFs don’t typically require as much trading and management as a mutual fund, which keeps costs low.
While it may appear that trying to outperform the market would be a better choice for investors (who wouldn’t want to outperform the market?) the truth is, it can be difficult to do this. Over a long period of time, the stock market has trended up, and therefore, a passive investment strategy could potentially follow that upward movement.
Another key difference is that ETFs trade on the stock exchange, whereas a mutual fund is bought and sold directly through the mutual fund company at the present day’s closing price. By trading on the stock exchange, ETFs offer investors flexibility to trade throughout the day, with trading commissions comparable to stocks. What’s more, investors don’t need to concern themselves with individual stock selection, because the ETFs typically have diversification baked into the product.
BENEFITS OF ETFS
ETFs have several other attractive features that may make them appealing to any type of investor:
Low risk: They are not risk free, but may be less risky than single stocks
Access to any asset class: the versatility of ETFs is endless
Diversification: You can build a complete portfolio with a just a few ETFs
Easy to trade: Any discount broker or robo-advice platform sells ETFs
Transparent: You can typically see exactly what is held in the ETF at anytime
Simple to understand: Most ETFs do not employ complex management strategies
Accessible: Anyone can invest in an ETF with just a few dollars
There are new ETF products being made available to Canadian investors every day as the ETF market continues to grow. Innovative features like no fee funds and single-ticket portfolios have only increased the appeal of these products.
If you haven’t yet included ETFs in your portfolio, it’s worth considering them now.