The world’s first ETF was launched on the Toronto Stock Exchange in March 1990. And over the last 30 years these funds have become hugely popular with investors: There are now more than 1,000 ETFs on the Canadian market, holding a combined $250 billion, according to the Canadian ETF Association
Learn more about ETFs — to determine whether they're a good choice for your portfolio.
What exactly is an ETF?
An ETF is a bundle of stocks, bonds or other investments pulled together with money pooled from a large number of investors.
When you invest in an ETF, you own a little piece of each asset that's part of the bundle. It's a way of getting some exposure to high-flying investments you might not be able to afford otherwise.
For example, that very first ETF, back in 1990, was invested in all the stocks making up the TSE 35 index, which consisted of the top 35 companies on the Toronto Stock Exchange. Similarly, an ETF that tracks today’s S&P 500 offers you the chance to put some of your money into pricey blue-chip stocks like Amazon. ("Alexa, make me some money.")
One reason ETFs are so appealing is that they're easy to buy, sell and follow. Investing in an ETF is very similar to investing in an individual stock.
How do ETFs work?
Like stocks, ETFs trade on stock exchanges under ticker symbols.
Just as Amazon uses the symbol "AMZN," the iShares Core S&P/TSX Capped Composite ETF, which tracks Canada’s most-watched index, trades under the symbol “XIC.”
The value of one share of an ETF is derived from the values of the assets making up the fund. Those can include:
- Commodities, such as gold or oil
The typical ETF is based on a financial market index and contains all of the individual stocks or other investments that make up the index.
As with stocks, you profit from an ETF when you sell your shares at a higher price than you paid.
How to invest in ETFs
ETFs are highly liquid and diverse — they have low barriers to entry — but they're not guaranteed successes. Your investment practices can make a huge difference in how things will turn out for you.
You need to do your research. Before sinking money into an ETF, it's wise to become as informed as possible. In most cases, the best way is to review the disclosure materials that ETFs are legally required to provide.
The two most important disclosures are the summary and the prospectus, which is a more comprehensive document that lays out all of the important details.
A prospectus will contain a ton of information. You might need some strong coffee to get through one, but it's an essential step for learning about the risks, investment strategies and costs of a specific fund, especially a newer one without much of a track record.
You must decide how you want to invest. Traditional brokerages sell ETFs, but they do so at a price. ETF investors may have to pay high commissions on their trades, or steep fees to maintain their brokerage accounts.
You can defer to financial advisers, who will put together an optimized portfolio suited to your goals.
Brokerage apps and robo-advisors — also known as automated investment services) — minimize the costs by using artificial intelligence tools to choose investments, make recommendations and help customers build strong portfolios.
There's also the more hands-on approach, with active trading apps like WealthSimple Trade, which offers a wide range of low-cost ETFs that you can invest in on its platform. You can even get a $10 cash bonus and commission-free trades when you open a Wealthsimple Trade account and deposit and trade at least $100.
And those looking to take control of their investments should certainly explore online trading platforms. The best sites offer resources and tools to help investors make informed decisions as they build and manage their investment portfolios.
How ETFs are different from mutual funds
ETFs have a lot in common with mutual funds, which also allow shareholders to own bits of many assets that have been bundled together. But here are a few examples of how ETFs and mutual funds differ:
- Trading frequency: Mutual fund shares may be purchased or sold only at the end of each trading day, and at a fixed price. An ETF can be bought and sold with as much freedom as you trade stocks — and, same as stocks, ETF prices fluctuate throughout the day.
- Management: A mutual fund has managers who actively decide on the assets that go into the fund's portfolio. An ETF is a passive investment with a portfolio usually built to match a market index, like the TSX.
- Size: Canada’s mutual funds held a massive $1.75.1 trillion as of November 2020, the Investment Funds Institute of Canada says. The respectable $250 billion invested in ETFs seems teensy by comparison.
- Costs: Mutual funds can be more expensive, because the managers need to be paid and because investors often face the potential for higher capital gains taxes than with ETFs.
- Requirements: Mutual funds usually have investment minimums, meaning you may need a few thousand dollars to get started. ETFs typically don't have these requirements — you can buy just one share.
Are ETFs right for you? Here are a few pointers to remember.
The advantages of ETFs
- ETFs may be a good choice if you're new to investing and want to dip your toe in the water. Their low cost makes it easy to get started, and the simplicity of buying and selling ETFs the way stocks are traded allows you to experiment without feeling tied down.
- Because ETFs are diversified, they spread your risk around and minimize the impact if one stock, bond or other asset in the bundle goes crashing.
- With no investment minimums, ETFs are accessible to a broad cross-section of investors.
The disadvantages of ETFs
- ETFs are low-cost, but not no-cost. Often there are commissions to be paid, and management fees. The expenses are rising as ETF companies find they have to spend more on marketing to stand out in what has become a very competitive business.
- ETF diversification isn't perfect. An ETF usually matches the makeup of a market index — but you could miss out on great investments that aren't part of the index. Plus, if you've got a stock ETF and one of the stocks is a dud, you can't dump it.
- The ability to buy and sell ETFs throughout the day isn't necessarily a good thing. If your ETF is having a rough couple of hours, you might be tempted to move your money around — which isn't smart if you're investing for a long-term goal, like contributing to your RRSP.