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What are Exchange Traded-Funds (ETFs)?

If you've been paying attention to the Canadian financial technology space in the past ten years, you might have noticed the proliferation of do-it-yourself investing tools. These tools allow you to take control of your financial future by skipping the high fees associated with financial advisors and investing your money yourself. While this might sound like an exciting new world, it's also a confusing one. Stocks, bonds, emerging markets, the terminology might sound like Greek to the average Canadian, and the idea of controlling your investments without the input of a financial advisor can be daunting.

That said, a product on the market can simplify do-it-yourself investing, and that is exchange-traded funds (ETFs). 

What is an ETF?

An ETF is an investment fund that holds many individual stocks and government and corporate bonds. An ETF can be purchased or sold on a stock exchange just like a regular stock and lets you buy a diverse assortment of securities within a single ETF. As a result, ETFs often have lower fees than other types of funds, including mutual funds. In addition, there are many different types of ETFs with varying levels of risk, which means you can choose a single ETF suitable for your risk tolerance.

How do ETFs work?

Here's how an ETF works: A fund provider (like Vanguard or Scotiabank) designs a fund to track the performance of a stock index or commodity like the S&P 500 or gold. The fund has its own ticker symbol, and investors can buy and sell shares of those ETFs on the stock exchange, just like they can buy and sell shares in a company. 

Types of ETFs

ETFs are a popular investment vehicle in Canada, and that means you can buy an ETF designed to track almost any index or commodity. Here are some examples of the types of ETFs available to buy in Canada:

  • Bond ETFs: these may include government and corporate bonds
  • Industry ETFs: these track a particular industry like oil and gas or real estate.
  • Commodity ETFs: these track commodities like crude oil or gold
  • Currency ETFs: these invest in foreign currency like the Euro or USD
  • All-in-one ETFs: these contain a variety of stocks and bonds that track several indexes

Generally speaking, the average do-it-yourself investor will only need a single all-in-one ETF to build a diversified portfolio. However, many seasoned investors prefer to own multiple ETFs.

ETFs vs Mutual Funds

ETFs offer a way for the average Canadian to manage their investments themselves, but is there a benefit to doing it yourself versus going with a mutual fund offered by one of the big five banks? The short answer is yes.

Mutual funds are a very popular investment option in Canada (currently, over 5,000 mutual funds are available in Canada). They work by pooling money from investors to invest in a portfolio of stocks and bonds. Unlike ETFs, which are designed to track an index (also called passively managed), mutual funds are run by a portfolio manager that purchases investors' shares. The portfolio manager will buy and sell shares while aiming to outperform a benchmark index like the S&P 500. Ideally, the portfolio manager will outperform their benchmark, but they don't always meet this target, and there is no way to know whether their strategies will pay off from year to year.

While mutual funds and ETFs differ in how they are managed, they also differ in how costly they are to you, the investor. Portfolio managers actively manage mutual funds, and so they come with much higher fees than an average ETF. For example, the average annual cost for a mutual fund in Canada is 2.23% of your total portfolio. On the other hand, a typical fee for an all-in-one ETF like Vanguard's All-in-One Growth ETF is 0.47%. While this may not seem like much, over time, the difference in costs, assuming both tools have the same returns, can add up to tens of thousands of dollars over the lifetime of your investment.

ETFs vs Stocks

Just like stocks, ETFs can be purchased on exchanges using their ticker symbol (for example, the ticker for the Vanguard All-in-One Growth ETF we mentioned above is VGRO). However, unlike stocks, ETFs represent a basket of stocks and bonds, whereas you are purchasing a share in a single company when you purchase a stock. Since ETFs include many different stocks and bonds, you can create a diversified portfolio by buying just one ETF. To make the same diversified portfolio by purchasing stocks manually, you need to buy many different stocks and bonds and monitor their performance carefully.

ETFs vs Robo advisors

Finally, how do ETFs compare to the other new kid on the block: robo advisors. Robo advisors and ETFs employ a similar investment strategy: to assemble a diverse basket of stocks and bonds that track an index. The primary difference between robo advisors and buying ETFs yourself is that a robo advisor will help you determine your risk tolerance and the ideal balance between stocks and bonds. A robo advisor will also invest your money automatically. All you need to do is set up a contribution.

ETFs, in contrast, need to be purchased using their ticker symbol through a discount brokerage, and there is no guidance offered on which ETFs are suitable for you. So you'll need to do that research on your own.

The extra benefits of a robo advisor result in higher fees, though only slightly. For example, the popular robo advisor Wealthsimple will charge you 0.60% - 0.70% per year.

 

Wealthsimple

Wealthsimple* offers one of the lowest MER rates in Canada, averaging between 0.4% and 0.5% in fees. Wealthsimple also offers a very diverse range of ETF options, with flexible Conservative, Balanced, and Growth portfolio options. Investments included in a Wealthsimple ETF portfolio include Canadian and American stocks, bonds, and real estate.

Wealthsimple also uniquely offers Socially Responsible and Halal Investing options, which create ETF portfolios built with socially responsible and Islam compliant investments.

Details

$25 bonus when you open and fund your first Wealthsimple Invest account* (min. $500 initial deposit)

Various investing options and savings accounts available

The Pros and Cons of ETFs

ETFs aren't the perfect investment choice for everyone. Here are the pros and cons of investing your money using ETFs.

Pros

  • Diversify: ETFs let investors buy various stocks and bonds across local and international markets with just a few or even a single fund. Assembling a portfolio that diverse used to be an arduous process.
  • Transparent: Mutual fund statements are only delivered monthly or quarterly, whereas ETF holdings are disclosed daily, so it's easy to see what is happening with your investments daily.
  • Low fee: Easily the lowest fee option for investing in Canada, ETFs let you assemble a diverse, balanced portfolio with no trading fees and very low annual fees.
  • Easy: All-in-one ETFs let you buy a balanced, diverse portfolio in a single click by simply purchasing more shares as your funds become available. There is no need to rebalance or spend hours researching the right stocks to buy.

Cons

  • Accessibility: To purchase ETFs, you'll need to use sign-up for a discount brokerage, link your accounts, transfer money in, and then buy shares.
  • Guidance: unlike mutual funds and robo advisors, the average discount brokerage offers no centralized advice on what ETFs you should buy. You'll need to do your research.

How to Choose ETFs

As we mentioned above, there is a wide variety of ETFs available in Canada, and the average discount brokerage offers relatively little advice on which ETFs to buy, so you'll need to do your research. If you are new to buying ETFs, a great place to start your research is the Canadian Couch Potato. This website advocates a passive investing strategy for the average Canadian and offers reviews and guidance on some of the most popular ETFs in Canada.

The first thing you'll need to determine is your risk tolerance, and that will help you choose the correct mix of stocks and bonds (also called asset allocation) in your ideal portfolio. Once you've determined your risk tolerance (for example, 80% stocks, 20% bonds are a typical asset allocation for the average millennial), you can choose the right ETF(s) for you.

If you are new to buying ETFs, we recommend you keep the process as simple as possible by choosing a single all-in-one ETF that reflects your ideal asset allocation. For example, Scotiabank and Vanguard offer all-in-one ETFs with various asset allocations to suit different risk tolerances. Here are some examples:

  • iShares Core Growth ETF Portfolio (XGRO): 80% stocks, 20% bonds
  • iShares Core Balanced ETF Portfolio (XBAL): 60% stocks, 40% bonds
  • Vanguard Growth ETF Portfolio (VGRO): 80% stocks, 20% bonds
  • Vanguard Balanced ETF Portfolio (VBAL): 60% stocks, 40% bonds

You can purchase the ETFs we've listed above through any discount brokerage in Canada and instantly create a balanced, diversified portfolio for yourself with minimal fees.

How to Buy and Sell ETFs

The easiest way to buy and sell ETFs is through a discount brokerage like Questrade or Wealthsimple Trade. These brokerages let you sign up and verify your accounts online, and you can open RRSPs and TFSAs to house your investments so they can grow in a tax-sheltered environment. Once you sign up, you'll need to link your bank accounts and transfer money to your brokerage account. This process can take several days. Once your money is available to trade, look up the ticker symbol of the ETF you wish to purchase and choose how many shares you'd like to purchase. Buying shares of a stock or ETF is called placing an order, and there are several different types of orders, including:

  • Market buy: enter the number of shares you want to purchase and submit your order, and that order will be filled at the best price on the market.
  • Limit buy: Choose the highest price you are willing to pay per share and the number of shares you want to purchase. Your order will only complete if and when the market price is below your limit. Limit buys help to buy stocks with a high level of volatility.

Once the order is filled, you'll receive a notification, and you'll see the shares you purchased reflected in your portfolio.

Some discount brokerages charge fees to purchase stocks and ETFs, and some allow you to make your purchases at no charge, so it's essential to pay attention to the cost of each trade when choosing a discount brokerage.

The bottom line 

ETFs in Canada are here to stay, and in our opinion, they are an easy, low-cost way to build a diversified portfolio that fits your risk tolerance. However, ETFs aren't as foolproof as a robo advisor, which may be a good alternative as an introduction to investing for your future.

There is a bit of a learning curve for investing using ETFs, but if you want the absolute lowest fee way to invest for your future, check out the websites and brokerages we mentioned above. You'll find the tools you need to choose the right ETF(s) for your situation and a discount brokerage that makes building your first ETF portfolio easy.