ETFs explained - MoneySense

ETFs explained

What is an ETF and how do you buy one?



Exchange-traded funds (ETFs) are attracting lots of attention these days due to their low fees and tax efficiency. However, as investments go they’re still pretty new, and would-be investors are bound to have lots of questions. So here is an overview of the benefits, risks and comparables of ETFs to help you get informed about this popular investment vehicle.


What is an index?

You know when they refer to the S&P 500 on the news? That’s an index.

In short, an index is a selection of stocks or bonds that represents a given market. Each index has rules about how many securities are
included and how they are weighted. Indexes are mainly used to measure changes in the market they represent.


The benefits of ETFs

•Quick and cost-effective diversification
•Easily bought and sold, like stocks
•Usually simple and transparent


How do ETFs compare to mutual funds and stocks?

Diversification Usually offer instant diversification. Usually offer instant diversification. You must diversify manually.
Fees The fees on ETFs are low. The average management fee (or MER) is just 0.40%. The fees on mutual funds are higher. The average MER on a Canadian equity fund is 2.56%. There is no management fee. As with ETFs, however, there is usually a commission of $5 to $29 per trade.
Transparency High (for broad-market index ETFs). The individual holdings are reported daily. Lower. Many mutual funds report holdings quarterly or semi-annually. Highest. You always know what you’re holding.
Flexibility High. ETFs can be used for almost any
investing strategy, from buy-and-hold
to day trading.
Lower. Mutual funds are generally
only suited for buy-and-hold strategies.
Unit values are set just once a day.
High. Stocks can be used
for almost any investing strategy,
from buy-and-hold to day trading.
Tax-efficiency High. ETFs tend to have lower
turnover and their special structure
reduces taxable capital gains.
Lower. Frequent trading of securities
and investor redemptions can
trigger capital gains.
Varies. Depends on your investing
strategy and what type of account
your stocks are held in.



The top 3 ETF risks

Exchange-traded funds (ETFs) carry risks, just like any investment. Before buying ETFs, keep in mind:

• There’s no guarantee that you’ll make money with an ETF, as no onecan predict how a market or sector will perform in the future.
• ETFs that track narrow sectors (such as oil or gold), or use complex strategies (such as leveraging) are more volatile than traditional index ETFs. This volatility increases your risk of suffering losses.
• ETF costs can be high when using dollar-cost averaging strategies (automatically investing small amounts on a scheduled basis) to build your portfolio. Your trading commissions can eat away at your total return.


How to open a discount brokerage account

A discount brokerage account lets you buy and sell stocks, bonds, ETFs, mutual funds and other investments by phone or online.

Unlike at a full-service brokerage, there is no one to call on for advice, so the trading commissions are much lower. You can open a discount brokerage account through your bank, or through an independent.

The major online brokerages include Scotia iTrade, Questrade, CIBC Investor’s Edge, QTrade, TD Waterhouse, RBC Direct Investing, and BMO InvestorLine. Look up the brokerage online and follow the directions to open an account.