ETFs: Beyond Low Fees

Considering an ETF? Here’s What You Need to Know

Exchange-traded funds (ETFs)ᶲ are famous for their low fees and convenience, but there’s more to them than meets the eye. Here’s how to make the most of your ETF purchase.

The first-ever ETF was actually launched in Canada in 1990. It tracked the performance of the 35 biggest stocks on the Toronto Stock Exchange by market cap. The ETF business didn’t take flight in the U.S. until three years later, and it hasn’t looked back since.

ETFs at a glance

When discussing ETFs, a good place to start is by comparing them to mutual funds, which have been a staple of Canadian portfolios for decades.

Like mutual funds, ETFs hold a range of investments, including stocksᶲ and corporate and government bondsᶲ. But unlike mutual funds,ᶲ which are priced at the end of each trading day, ETFs trade on stock exchanges, so they’re priced up to the second during the exchange’s operating hours—and you can buy and sell them, just like a stock.

Another difference: most ETFs aren’t run by a portfolio manager. Instead, their portfolios are set up to mimic an index, commodity price, or other basket of investments. There are ETFs that track everything from small cap U.S. stocks to foreign stocks and even gold and copper prices.

There are also hedged ETFs that let you invest internationally without having to worry about your profits being eroded by currency fluctuations.

Bottom line: it’s important for you to understand how your ETF is managed (or not), how they track, and how they are priced.

Fees are low, but management may be up to you

The first thing that comes to mind with ETFs is the lower fees than those of mutual funds. It’s not unusual to find ETFs with management expense ratios (MERs) of 0.2% of assets or less; compare that with Canadian mutual funds which can be 2% or more. 

In addition to management fees, you pay trading fees when buying an ETF, as you would with a stock. But with ETFs you won’t have to pay the sales fees that can apply to mutual funds, namely a front-end load, which is charged at purchase; or a back-end load, which is charged if you sell your mutual fund within a set timeframe.

However, there’s more to comparing mutual fund and ETF fees than just stacking up their MERs. You’ll also want to look at past performance, and it pays to keep in mind that the charts you usually get from fund providers illustrate performance net of fees (though you will want to confirm this).  And while past performance is not indicative of future performance, it does give an investor a good sense of how an investment reacts during different times in a market cycle.

So if a mutual fund is performing well even with fees included, paying for that manager’s skills may be a good investment on its own. For example, a manager can help protect against losses by rotating into defensive sectors or going to cash.

Easy way to diversify 

ETFs can be a good low-fee way to target a specific part of the world. That’s because foreign-focused ETFs trade in North America, saving you the complication of buying stocks on unfamiliar foreign exchanges. And there are plenty of international ETFs out there, including those that target global stocks as a whole and those that focus on individual countries and regions.

ETFs can also target specific sectors such as tech, energy, health care, or finance.

Useful for commodity investing

Similarly, you can also use ETFs to add to your portfolio’s commodity exposure. Many investors interested in holding gold do so through an ETF since it alleviates the stress of storing physical gold and can be more economical and efficient when you come to sell it.

Commodity ETF options go well beyond gold: you can use these funds to invest in everything from natural gas to copper and even soybean futures.

Your advisor can help 

There are numerous advantages to ETFs, but they can be a complex investment vehicle. In addition to the types discussed above, there are leveraged ETFs, closed fund ETFs, and liquidity may be an issue with some.

Your advisor can help you build ETFs into your portfolio that is right for your goals, timeline and risk tolerance.