Exchange-traded funds (ETFs) are the new darling of self-directed investors. Although they were first introduced several years ago, the democratization of investing has made it easier than ever to buy ETFs. The number of ETFs available to trade continues to grow. 

Like many people, you’re probably wondering if this is just a fad. Are ETFs really beneficial? What are their limitations? How do you actually buy them? How do you make the right choice? This guide contains all the essential information you need to understand about ETFs and get started in the market.

What is an ETF?

Exchange-traded funds (ETFs) are on a roll. They are among the fastest-growing investment products in the world. There are 942 funds in Canada, an increase of 36.2% in one year, with $319.6 billion in assets under management. 

This data comes from the Canadian ETF Association (CEFTA). Why is this so? The ability to manage a simple product autonomously is certainly one of the reasons why many investors are interested in it. As an alternative to mutual funds, which are traditionally purchased by a financial advisor, ETFs are often designed to diversify your portfolio. Not only that, you can buy ETFs based on your investor profile and at low cost.

An ETF is a basket of securities in a single fund. Just like shares of publicly traded companies, ETFs are bought and sold on the market. Many aim to reproduce a particular index, such as the S&P 500 or the TSX. Others are indexed to a certain market sector, such as technology or natural resources

Therefore,  ETFs offer a lot of flexibility and provide a return similar to that of the benchmark. As investors, ETFs allow you to gain exposure to sought-after sectors and get the diversification you want within your portfolio. Let’s outline some benefits of ETFs for investors.

ETF benefits for investors

The value of individual stocks, i.e. the shares you buy from a given company, can vary drastically in a short period of time. The price changes with good and bad news. In fact, stock prices change every day according to supply and demand. If more people want to buy a stock (demand) than sell it (supply), its price rises. 

Market sentiment

Talk of inflation, consumer and employment indicators, and the U.S. debt are factors that can cause investors to worry about the market.  That can cause the prices at which stocks are bought or sold to fall. How? 

If many investors are trying to sell a stock at the same time and the number of people willing to buy it is low, the price will fall. Predicting the price change of a stock is complex, as investor sentiment and expectations often have the final say in market prices.

Volatility 

An ETF tries to replicate a specific set of stocks or a market index. It does this by including a representative sample of the stocks that make up that set, according to their respective weights. It may even include all the stocks that make up the index that it’s tied to. For example, an ETF indexed to the Toronto Stock Exchange (TSX) would hold pieces of all the companies that trade on the TSX.

In this way, it reduces the effects of market volatility resulting from price fluctuations. With a diversified portfolio, it is much less likely that all the securities in the portfolio will underperform at the same time. The gains of some stocks help offset the losses of others.

Diversification

Diversification includes a balance among the major sectors of the economy, which evolve at different rates: financial services, energy (such as oil and gas companies), materials (such as mining companies), industrial (such as manufacturers and railways), consumer (such as restaurants and supermarkets), telecommunications, technology, health (such as pharmaceutical companies) and utilities (such as electricity companies).

Read More: Five Pitfalls to Avoid When Investing in the Stock Market

Liquidity and flexibility

Since ETFs trade on the stock exchange, like common shares, you can sell yours whenever you want. Whether you need this money to buy a house or go back to school, it is available quickly. Your investments can be liquidated at the right time, without the need to wait for the end of a term.

ETFs can hold stocks, bonds, precious metals, currencies and other assets. These are similar products to mutual funds, but most ETFs are passively managed and have lower fees than their “cousins.” Within the ETF family, you can find a wide range of products: equity-only ETFs, industry- or sector-specific ETFs, global ETFs, actively managed ETFs, etc. Note that the majority are passively managed. What is passive and is it a quality? 

Read More: Stocks, bonds, ETFs, WTF!

Passive investing 

Compared to an index fund, active management can outperform and beat the market. “Beating the market” means making a higher return than the stock market. But at what cost? Under what conditions? 

The fees for actively managed funds are higher because you have to pay the people who do the work! And the result is not guaranteed. Your actively managed fund may also underperform. 

Do you plan to do the management work yourself? Are you prepared to follow the markets every day, gain knowledge and confidence in your forecasts? Day Trading should be approached with caution. 

According to Dalbar, individual investors’ returns are lower than the stock market indexes. Several cognitive biases come into play and prevent them from picking the winners or making logical choices over the long term. 

Passive investing can then become a very pragmatic choice, and it pays off! For independent investors, choosing an ETF that reproduces a stock market index is likely to save them a lot of time and money. A few minutes a year to continue to invest your savings and we will talk about it again in 15 or 20 years, by the beach, with a margarita in hand (or a beer, I don’t judge!).

Who are ETFs designed for?

ETFs are, in general, not for investors who want to beat the market by taking significant risks. Their key qualities of diversification, liquidity, flexibility and passivity make them ideal for beginner and intermediate investors who have little time to invest. In other words, they are suitable for the vast majority of people!

Read More: Beginner’s Guide to ETF Model Portfolios in Canada

Who provides ETFs?

According to the CEFTA, there are 40 ETF providers in Canada. Those with the largest market share are BlackRock Canada and BMO Asset Management, with over 25% each, followed by Vanguard Investments Canada, Horizons Management, CI Investments, Mackenzie and TD Asset Management.

Read More: 5 Best Online Brokers for ETFs Investing


While you may recognize major Canadian banks like Bank of Montreal (BMO) and Toronto Dominion Bank (TD) in this list, there are other big players that specialize in ETFs that are a little less known to the general public. Rest assured that they have been around for quite some time now. BlackRock and Vanguard, for example, were founded in the 20th century.

Read More: Can BMO ETFs Earn Your Trust?

What is the risk associated with ETFs?

ETFs are no riskier than mutual funds. It’s all about what’s inside them! By their nature, there is nothing in an ETF that exposes investors to increased risk. 

Sure, it is not a guaranteed investment and there is always a risk of incurring losses. But that risk is no higher with an ETF than with any unsecured investment. The risks associated with a fund are similar to those of the investments that make up the index and that it reproduces.

Performance

An index fund may still not perform as well as the index or sector it replicates. Why might this be? Because the proportion of investments that make it up may not be exactly the same. 

Read More: The Pros and Cons of Investing in Index Funds

Asset allocation 

The particular index that the ETF tracks is important because it determines how investments are weighted in the ETF. Two indices that hold the same investments in different proportions will see very different returns.


Replication 

Some funds aim for full replication while others choose optimization or synthetic replication. By targeting full replication, an ETF holds all the securities in the index, following the same weightings. This strategy usually leads to a very close reproduction of the underlying index. When the index changes, the composition of the portfolio is adjusted to continue to reflect it.

Optimization

Optimization uses a sampling process to create a portfolio that closely matches the characteristics of the index, while aiming to control trading costs and increase liquidity. Synthetic replication is based on derivative instruments, such as option contracts and swap agreements with third parties. When it is difficult to make certain trades, this strategy allows the ETF to reflect the performance of the index without actually holding the securities.

What are index ETFs?

Let’s summarize the benefits of index ETFs. These are passive investments, meaning that they aim to reproduce an index. These ETFs are not looking to outperform their benchmarks. It can be a stock market index or an index that tracks bonds, for example. Index funds can also track a particular commodity, such as oil, or focus on a single region.

An index is defined as a list of securities that tracks their value. It may be a collection of stocks traded on the same exchange, like the TSX, or belonging to the same sector of the economy. The portfolio of such a fund is only changed if the components of the index are adjusted.

The particular index that the ETF reproduces determines how the investments are weighted. Several indices may hold the same investments but in different proportions. So an ETF that tracks one or the other will perform differently, even if both have Apple stock in their bundle!

Why choose stock index ETFs? Since 1927, the S&P 500’s compound annual yield has been close to 10% when the dividend is taken into account. It’s hard to go wrong with this choice.

Read More: 3 ETFs for Canadians Looking to Invest In the S&P 500

Examples of index ETFs

Even though this guide is not a full list, we give you some examples of funds that fit this description.

Vanguard VFV

An S&P 500 index ETF that seeks to reproduce the S&P 500, before expenses. It tracks the performance of a broad U.S. equity index that measures returns on the investment of U.S. large-cap companies. At the time of writing, the S&P 500 has grown 15.16% year-to-date, while VFV stands at 15.17%. Its management expense ratio is 0.08%. All information is available in its prospectus.

Desjardins DCU

Named the Canadian Bond Universe Index, this ETF tracks the Solactive Canadian Bond Universe Index. Its management expense ratio is 0.12% and it goal is to provide a fixed income. It is therefore a very different ETF than those who invest in stocks. Designed for investors looking for stable income, it is a diversified portfolio of federal, provincial, municipal and corporate bonds.

As you can see, some fees are associated with index ETFs, but they are generally very low. They shouldn’t eat up a large portion of your profits. 

Other examples of index funds? iShares NASDAQ 100 index ETF, BMO Dow Jones Industrial Average Hedged to CAD Index ETF and SPDR S&P 500 ETF Trust are among them! The name of the index tracked is very often found in the name of the fund, to make life easier for investors!

Index funds

In summary, index funds closely track and replicate a benchmark, but may not perform exactly like it. They are passively managed and charge low management fee. 

They can reproduce various types of indices, for example stock or bond indices. Tracked indices can help gauge the results of your current investments, such as various types of mutual funds and ETFs. If your returns are consistently lower than the indices, ask yourself questions!

All-inclusive ETFs

There are other types of “all-inclusive” things other than resorts in the Caribbean. All-inclusive, or all-in-one, ETFs are likely to make you just as happy. The ultimate passive investment, they can be used on their own, meaning all your money goes into one ETF. Either way, these all-inclusive ETFs are designed to take the guesswork out of investing!

These ETFs offer typical portfolios, such as growth, balanced or conservative. Do these words sound like gibberish to you? Start by asking yourself these questions:

  • How much money do I want to invest?
  • What goals do I want to achieve? 
  • How long can I leave this money invested? 
  • What level of loss can I tolerate? 
  • Do I want to generate stable income, guarantee the security of my capital or invest to grow it?
  •  Am I planning a job change, a return to school or anything that will require me to have access to my money easily? 

These questions will help you establish your investor profile, which will guide you towards an informed choice. Your profile takes into account your objectives, investment horizon and risk tolerance as well as your financial situation and investment knowledge. 

ETFs for your time horizon & risk tolerance 

The time horizon is calculated according to the number of years between the time you invest and the time you disburse to achieve your project. As for risk tolerance, you should imagine losing 20% or 10% of the amount invested to assess your ability to manage your emotions (and your budget) if this happens. 

You can divide your assets into a few investments with different goals.

Why choose all-inclusive ETFs? Because once you’ve established your risk profile, your entire portfolio can fit into one ETF. That’s why they’re called “asset allocation ETFs.” 

You can use only one ETF and watch your loot grow over several years. Similar to index ETFs, they offer the equivalent of a portfolio of multiple ETFs combined, while the index ETFs mentioned above buy securities directly. In fact, an all-inclusive ETF is often a portfolio of multiple index ETFs.

Read More: Canadian all-in-one ETFs: an attractive alternative to robo-advisors

Examples of all-inclusive ETFs

All inclusive ETFs are designed based on risk level. The higher the risk, the higher the potential returns for better growth. Some are 100% equity, some are 60%, and some are even less.

Horizons HGRO

HGRO is composed solely of equity ETFs, such as the Horizons NASDAQ-100 index ETF and the Horizons Europe 50 index ETF. It is specially designed for unregistered accounts. The underlying ETFs in the portfolio do not make ongoing taxable distributions of investment income or dividends. Geographically, it covers the entire world. Its management expense ratio is 0.16%.

BMO ZBAL

This balanced ETF is designed to provide moderate long-term capital appreciation and income by investing in global equity and fixed income ETFs. Like HGRO, ZBAL is a fund made up of funds. Its management fee is 0.20%.

Other examples

BlackRock’s Income Balanced ETF Portfolio (XINC) fund, which consists mainly of bonds, and Horizons’ Balanced TRI ETF Portfolio (HBAL), which is 70% equities.

Specialty ETFs

The demand is on the rise and providers are creating new ETFs every year. Do you have a special interest in health or technology? There is an ETF for you.

Why choose specialty ETFs? When you sense that a sector will take off, you may be tempted by a specialized ETF. These don’t offer the level of diversification of index ETFs and you’ll need to balance your entire portfolio yourself. 

Unless you’re looking to get an overweight sector? You can use these to supplement your portfolio by investing a smaller amount in a sector you like. It could even allow you to beat the overall performance of major stock indices. For example, in my case, I like real estate, which gives an interesting dividend and shows good growth (for now).

Read More: Cryptocurrency ETFs: What to Know Before You Buy

Examples of specialized ETFs

Real estate, health, precious metals, lark! There is something for everyone. One example is the price of gold with iShares Gold Bullion ETF (CGL), the oldest and largest gold ETF in Canada. It has a management expense ratio of 0.55%. 

In Healthcare, CI Investments offers the CI Health Giants Covered Call Options ETF (FHI). It pays dividends and has a management fee of 0.65%.

Read More: 3 Healthcare Stocks That Can Beat the TSX

Does telecommuting inspire you and you want to turn to technology? iShares S&P/TSX Capped Information Technology Index ETF (XIT) invests primarily in equity securities of Canadian issuers involved in the information technology sector. Hello Shopify and Lightspeed! Its management expense ratio is 0.61%.

Read More: Top Canadian Tech Stocks That Should Outperform the TSX in 2022 and Beyond

How do you make money with ETFs?

With an ETF, you keep a larger percentage of returns compared to mutual funds. However, the two products are quite similar. Mutual funds charge fees ranging from 2% to 2.7%, while ETFs stick below 0.5% in most cases. 

Does your mutual fund outperform an ETF? Not necessarily. If, once the management fee is deducted, the return remains higher, it’s probably not worth swapping your mutual fund for an equivalent ETF. But it’s worth checking out!

Lower fees

A fee of 2.5% is equivalent to $250 on an investment of $10,000, while a fee of 0.20%, for example, takes only about twenty dollars. Over time, your savings and investments will likely grow (we hope so!). When you add up all that $250 or more, you’re looking at tens of thousands of dollars that you’re missing out on. 

Note, however, that you should always check the management fees of each ETF because some are specialized and their fees are then a little higher. Some are even actively managed, with fees approaching those of mutual funds. It’s up to you to see if it’s worth it. Will the return be there? Use the Hardbacon Investment Fees Calculator to find out! 

Dividend income

With ETFs, you can also receive dividends. It all depends on the product chosen. For example, Vanguard’s VRE, a real estate fund ETF that I like, pays dividends monthly. On the product sheets, you need to look for the yield and its frequency of distribution (Yield) to know how much you will receive.

Read More: Ultimate Guide to REITs in Canada

Capital gains

Another way to make money with your ETF shares is… just to sell them. After a few years of taking an interest in the stock market, do you feel you have the makings of a day trader? Go for it! 

On the shares you sell, you will recover your starting capital, with, hopefully, a capital gain (the return). Half of that gain is taxable at your marginal tax rate, unless the investment is in a TFSA, for example.

Read More: The Ultimate Guide to TFSAs

How do you get an ETF?

We’re getting into the practical part. You can buy an ETF through an advisor, but to save on fees, which is one of their great advantages, you are better off with direct brokerage or a robo-advisor. Don’t worry, it’s simple. You need a phone or a computer, and you’re in business!

Here are the main steps:

  • Open a direct brokerage account, for example with National Bank, Desjardins, Wealthsimple or another financial institution. Try our tool to compare brokerage platforms to find the right one for you. 
  • Choose the type of account you want, following the rules and contribution limits (TFSA, RRSP, not registered, etc.).
  • Transfer money from your checking account. It will remain in your cash balance until you have chosen your ETF. You don’t need to know which one you’ll choose when you open the account and transfer the funds.
  • Allow time to view the data of the ETFs you are interested in. For example, check their management expense ratio and past performance. Choosing an ETF that trades on the Toronto Stock Exchange in Canadian dollars is the easiest way to start when you live in Canada.
  • Place your order by placing an order at the market! There are other types of order, but let’s start with basics.

Direct brokerages and robo-advisors

Recently, National Bank and Desjardins direct brokerage no longer charge commissions to place an order. Wealthsimple Trade has been operating this way for a long time. 

You can therefore invest small amounts periodically. This strategy can be interesting in a volatile environment. If there is a drop and then the market rises, you will benefit. 

As for robo-advisors, they take care of all the management of your investments after having sent you a questionnaire but come with additional costs. These fees are still lower than those of real advisors. This is the case of Wealthsimple Invest, for example.

Read More: The 10 best robo-advisors in Canada

Investor resources

How do you keep track of your stocks and improve as an investor? You can get information directly from the Toronto Stock Exchange (TSX) website, browse the knowledge base of your brokerage platform or visit specialized sites like Morningstar. Morningstar offers several tools, including an ETF comparison tool.

Read More: The top stock market analysis websites in Canada

Can I put an ETF in a TFSA or RRSP? 

Yes, it’s even a great idea! The prospectus of each ETF should specify the type of eligible account and the applicable tax treatment. However, you are solely responsible for not exceeding your contribution room.

In general, gains made through the TFSA are not taxable. As for the RRSP, it is only at the time of withdrawal that you have to pay tax, since it is then considered ordinary income. 

Read More: RRSPs vs TFSAs

However, several subtleties should be understood. For example, taxing dividends could undermine your return. Platforms will have you sign a document authorizing them to take these amounts directly.

Read More: Dividend Stocks: Is it Better to Own Them in a TFSA or an RRSP

A word about taxes

We are always afraid of forgetting a small detail that will cost us dearly in taxes! This is normal since it is a very complex issue.

Read More: 30 ways to pay less income tax in Canada

The investment vehicle you choose will have a major impact on your return. We are talking about TFSAs, RRSPs and non-registered accounts, mainly. The TFSA, it is called the “tax-free” account, when it generates income from interest, capital gains or dividends, you don’t have to pay anything. Except in the case of dividends from foreign shares, which are subject to withholding tax. 

Non-registered investment accounts

In a non-registered account, interest and dividends received are paid each year. However, as long as you don’t sell your shares, you are not taxed on the capital gain (since you didn’t actually receive it). This is one of the reasons why the capital gain is the darling of many investors. 

Let’s continue exploring the impacts of an unregistered account. Interest income is fully taxable. This is interest earned on investment contracts such as guaranteed investment certificates (GICs) and bonds. Therefore, it should be avoided, except in a TFSA, RRSP or for someone with very little risk tolerance. 

If you make $1,000 and your marginal tax rate is 37%, you will pay about $370 in taxes. By generating a capital gain, only 50% of this amount is taxable. You earn $1,000 but you pay tax on $500 only. In addition, there are two types of dividends: eligible and non-eligible or ordinary dividend. Canadian (eligible) dividends are usually eligible for the dividend tax credit.

Read More: The Dividend Tax Rate in Canada: What You Need to Know Now

ETF units are like stocks, they can only distribute dividends or capital gains. For detailed information on the taxation of a particular ETF, please do not hesitate to consult the ETF’s prospectus and the documents made available by management.

FAQs

How do I buy an ETF in Canada?

To buy an ETF, you either have to go through an advisor, which comes with higher fees, or save money through direct brokerage or robo-advisors.

Are ETFs the same as mutual funds?

No. Even though mutual funds may contain the same basket of securities, they have higher fees than ETFs and are bought and sold only once a day, usually when the markets close. They are managed more actively and sold by brokers or companies. They also provide access to sectors and companies that are more niche than ETFs.

What are the best ETFs in Canada?

There is no definitive answer, since it depends on your investor profile. Brokers such as the NBDC or Interactive Brokers can guide you in your decision-making.

How are ETFs taxed in Canada?

It depends on the type of account in which you place your ETFs. For example, a TFSA is tax-free, but a non-registered account means that interest and dividends are taxable. It is therefore important to be well informed when buying an ETF which account is eligible and what is the applicable taxation.

Are ETFs the same as index funds in Canada?

Both follow an index, but the big difference is that ETFs can be traded throughout the day, while index funds are only bought and traded at the close of the markets.

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