What is an ETF?
An Exchange Traded Fund (ETF) is a type of investment that tracks other investments’ growth. ETFs grow in accordance with stocks, bonds, commodities, or a mix of all three. You can buy and sell them easily on stock exchanges.
The most common ETFs track the progress of market indexes. A market index is a basket containing many stocks. For example, in a market index ETF, you might find Apple, Microsoft, Telus, RBC, and hundreds of others. By investing in many companies at the same time you reduce the risk of investing.
In a market index ETF, if one company fails, it is not the end of the world. Among the hundreds of companies in the ETF, your losses might even be relatively unnoticed. Instead, the ETF will rise steadily as the average combined value of its companies rises.
When people think of the stock market, they usually have mixed feelings. On one hand, picking the right stock can make you a lot of money. On the other hand, picking the wrong stock can put a significant dent in your savings.
Finding the best stock on the market can be like finding a needle in a haystack. In the words of Benjamin Graham, “Why look for the needles if you can own the whole haystack?” Instead of gambling with one stock, you can invest in an ETF (the haystack).
What are the Types of ETFs?
ETFs generate a lot of demand in the stock market. The most popular types of ETFs include the following.
Equity ETFs: These funds include broad market indexes and sector-specific indexes. Risks vary depending on the market/market sector.
Fixed-Income ETFs: These funds track bonds and stocks paying dividends. Although their gains may not be astonishing, they are usually considered safe investments.
Commodity ETFs: These funds can track gold, silver, copper, wheat, or any other commodity. Sometimes, fund managers track these prices with the use of futures contracts. Note this technique may not perfectly reflect current commodity prices. Some investors use these ETFs to maintain the value of their money. Others use them to speculate.
Currency ETFs: These funds can give you exposure to foreign currencies. They are also used in both defensive and speculative investment strategies.
All ETFs display a management expense ratio (MER). This figure gives investors an idea of how much money goes towards operating costs every year. Most ETFs also pay dividends.
Sector Tracking ETFs
BMO Equal Weight Oil Gas Index ETF (ZEO)
This equity ETF holds stocks in large-cap Canadian oil companies. Its list of holdings includes renowned firms such as Cenovus Energy Inc, Canadian Natural Resources Ltd, Suncore, and many more. ZEO’s price and dividend payment will be highly affected by changes in oil prices. As of November 22, 2020, its dividend is 7.53%. Its management expense ratio is 0.66%.
Physical Gold ETF
iShares Gold Bullion ETF (CGL.C)
For centuries, investors have used gold to hedge against inflation. But, buying and storing gold bricks can be a hassle. Alternatively, investors can buy shares in CGL.C, which holds $625 million in physical gold. Its share price is almost perfectly correlated with the share price of gold. Its management expense ratio is 0.56%
Crude Oil ETF
Horizons Crude Oil ETF Units Class A (HUC)
With the use of futures contracts, this commodity ETF aims to track light sweet crude oil prices. Crude oil futures are generally traded in US dollars. Unfortunately, the process of hedging USD to CDN results in slightly higher operating costs. For this reason, its management expense ratio is 0.88%.
Natural Gas ETF
Horizon Natural Gas ETF (HUN.TO)
This commodity ETF uses futures contracts to approximate the returns of natural gases. Given this sector’s volatile nature, most investors buy shares for short-term speculation. This fund, which is hedged on the Canadian dollar, has a management expense ratio of 0.88%.
United States Copper Index Fund ETF (CPER)
This commodity ETF also uses futures contracts as it approximates copper’s price movements. Unfortunately, you can only buy it in US markets. Its management expense ratio is 0.80%.
iShares SP/TSX Capped Consumer Staples Index ETF (XST.TO)
This ETF tracks a basket of companies proclaimed to be Canadian Staples. Its top holdings include famous names such as Couche Tard and Metro. It has had constant returns over the past 5 years as the Canadian economy has expanded. Although its expense ratio is 0.55%, its dividend yield is 0.75%.
BMO Equal Weight Industrials Index ETF (ZIN.TO)
This ETF tracks the most prominent industrial stocks on the TSX. The list of holdings includes Superior Plus Corporation, Canadian National Railway Company, and many others. Close to the same amount of money is devoted to each holding. Its expense ratio is 0.55%, and its dividend yield is 3.16%.
First Trust US Health Care ETF (FHH-T)
The healthcare sector has entered the spotlight with the emergence of COVID-19. Even without a pandemic, healthcare can be a safe investment. It is a service that people will always need. FHH-T gives investors exposure to 84 companies, including Pfizer, Moderna, and Johnson Johnson. Its management expense ratio is 0.78%.
iPath Series B Bloomberg Coffee Subindex Total Return ETN (JO)
This fund aims to track the price movements of coffee. It does not own physical coffee beans. It tracks the price with the use of futures contracts. Note that you can only buy JO on US exchanges. Its expense ratio is 0.45%.
IShares SP/TSX Global Gold Index ETF (XGD)
It holds companies that mine, produce and store gold in North America and South Africa. Unlike CGL.C, XGD is an equity fund. Nonetheless, its price movement almost mirrors the price movements of gold. It pays a dividend of 0.12% and has a management expense ratio of 0.61%.
BMO Aggregate Bond Index ETF (ZAG)
ZAG provides a perfect basket of bonds for investors to turn to in times of market turmoil. Its list of holdings includes both provincial, federal and corporate bonds. These holdings consist of short, medium, and long term bonds. All bonds have a maturity period greater than one year. This fixed income ETF has a management expense ratio of 0.09% and yields a dividend of 2.90%.
iShares Core Canadian Short-Term Bond Index ETF (XSB)
With a holdings list of 40 bonds, this ETF also provides diverse exposure to the bond market. Around 2/3 of its holdings are government bonds, and the remaining 1/3 are corporate bonds. It is known as a short-term bond ETF because the average maturity term is 3 years. Its management expense ratio is 0.10%, and its dividend yield is 2.25%.
Horizons Silver ETF (HUZ)
This commodity ETF tracks silver. While it does not use physical silver to back its value, it still maintains a close correlation to the metal’s price using futures contracts. Its management expense ratio is 0.79%.
Market index ETFs will give you the best risk/reward ratio in the long run. These ETFs will give you exposure to the whole market and all its sectors. With exceptional diversity, these ETFs rise at a steady pace. Market index ETFs may experience crashes during times of recession. But, when the economy expands, these funds undergo eyecatching growth.
iShares Core SP 500 Index ETF (XUS)
This fund represents the world’s most renowned index, the SP 500. The SP 500 index is made up of the 500 largest publicly-traded companies in the US. The growth of the SP 500 comes from the 11 main market sectors in the US economy. Over the past 20 years, it has seen colossal growth, despite 3 economic recessions. Its dividend yield is 1.83%, and its management expense ratio is 0.10%.
iShares NASDAQ 100 ETF (XQQ)
XQQ tracks 107 companies on the NASDAQ. The majority of these stocks are technology companies. Some say this means the fund has more potential for growth. Because XQQ puts a large emphasis on tech, it is riskier than XUS. Nonetheless, the index tracked by this fund has recovered from every market crash it has seen. Its dividend yield is 0.32%, and its management expense ratio is 0.39%.
You can get exceptional diversity within a market index fund. But, you can get even more by investing in an international ETF. International ETFs can invest in major market indexes of many countries at the same time. They will grow with even more of a steady, predictable pace, with even less risk.
iShares Core MSCI AC World ex Canada (XAW)
This fund will give you exposure to Europe, Asia, the US, Australia, and many other regions. It is meant for the long term. As the world economy progresses, so will this fund. Its dividend is 1.70%, and its management expense ratio is 0.22%.
iShares Core MSCI EAFE IMI Index ETF (XEF)
This fund offers broad exposure to 1500 stocks from Asia, Europe, and Australia. It is also designed for the long term. Its dividend is 2.26%, and its management expense ratio is 0.22%.
ETFs in Emerging Markets
If you would like to take a slightly bigger risk, you can invest in emerging markets. These funds invest in regions projected to experience large sums of economic growth. Assuming they meet expectations, they could have larger growth rates than broad international funds.
Vanguard FTSE Emerging Markets All Cap Index ETF (VEE)
This fund invests in companies located in China, Taiwan, Singapore, and other regions experiencing rapid industrialization. Even though it has been volatile, it was able to rise 40% over the past 9 years. Its dividend is 2.25%, and its management expense ratio is 0.24%.
iShares MSCI Emerging Markets Index ETF (XEM)
XEM provides exposure to the same emerging markets as VEE. However, XEM tends to invest more strictly in medium and large-cap companies. Its dividend is 1.54%, and its management expense ratio is 0.80%
Best ETFs with Dividends
These ETFs will track a basket of companies that pay high dividends. The fund’s large dividends can be reinvested to accelerate your portfolio’s growth rate. If you would like, you can also receive the dividends in cash as a form of fixed income.
iShares US High Dividend Equity Index ETF (XHU)
Defensive investors favour XHU as it pays dividends monthly. Historically speaking, this ETF has yielded dividends equal to 3%, or more, every year. The 75 companies that make up this ETF are capable of paying consistently. Even with the COVID-19 pandemic, XHU yielded 3.59% in dividends during the year 2020. Its management expense ratio is 0.33%.
SPDR Portfolio SP 500 High Dividend ETF (SPYD)
SPYD tracks 80 large-cap and blue-chip companies that pay reliable dividends. Unlike XHU, SPYD pays dividends every 3 months. These payments add up to 5.5% yearly. Note that this security can only be bought on US exchanges. Its management expense ratio is 0.07%
Like all stocks, ETFs are traded on the stock market. To buy shares, you will have to open up a trading account. You can easily open an account online through Questrade. Many firms offer trading platforms (ex: TD, CIBC, Scotiabank, etc…). Although they are reliable, Questrade’s trading platform is renowned in the investing community as it grants access to both Canadian and American markets.
Setting up an account is simple.
The link below will bring you to Questrade’s home page. In the upper right-hand corner, there is a button that reads “open account.” You will then have to provide your social security number and the answer to a few simple questions.
Your account may take a couple of days to get approved. Following approval, you will be given an account number, which you can use to wire in money.
How to Buy ETFs
You are now ready for the final step: buying the ETF. First, type the ticker (ex. SPDR) in the search bar. Then, press the “buy” button. Finally, type in the number of shares you would like to purchase and confirm your order. There may be a small fee attached to the cost of your trade. However, this fee will most likely be less than $1.
If you wish to purchase an ETF on a US exchange, Questrade will automatically convert your money to US dollars for you.
ETFs Versus Mutual Funds
ETFs and Mutual funds are similar in that they both can invest in baskets of stocks. But, unlike ETFs, Mutual funds don’t generally invest in commodities. There are many other differences between the two financial products.
For starters, ETFs are more passively managed than mutual funds. This is not necessarily a bad thing. Many studies have indicated that passively managed funds experience more success in the long run. Also, because passively managed funds spend less money on management, their management expense ratios are lower.
ETFs can also trade like stocks. Their fees aren’t expensive, and they can be bought or sold many times in one day. On the other hand, mutual funds may have expensive fees, and they can only be traded once per day.
Are Exchange-Traded Funds a Good Investment?
This depends on the type of ETF. It is safe to say that market index ETFs will perform well in the long run. However, it is not so black and white for commodity and currency ETFs.
Some commodity ETFs like gold, for example, have been used by investors to preserve the value of money. Other commodities like oil, for example, have been used by speculating investors. The success of these investments depends on how much knowledge or luck investors may have. It is possible that an investor bets on a currency or commodity that shows poor performance.
What ETF is Right for Me
Before investing in an ETF, you will want to identify two facets of your life. One: how long you are willing to invest. Two: your risk tolerance.
Even though most ETF prices change slowly, they all have different risk levels. As well, they all offer different potential for reward. For example, an ETF representing technology stocks will be riskier than an ETF representing the entire market. If you can tolerate the extra risk, you might want to invest in a technology ETF. After all, it can grow faster than the rest of the market.
If you are saving for education or retirement, investing in the entire market may be a safer strategy. This way, even if the whole technology sector crashes, your ETF will still maintain most of its value. You will still have your money when you need it.
With most market ETFs, it is best to hold your position for the long term and ignore daily price changes. But, if you are speculating on oil, for example, your holding period will depend on your investment strategy. If you sell your ETF before holding it for one year, your gains will be subject to short term capital gains taxes. This tax rate would be noticeably higher for most Canadian citizens.
The Bottom Line
Exchange Traded Funds are a great investment tool for Canadians. With ETFs, you can gain exposure to market sectors/indexes, commodities, bonds, and much more.
Market index/sector ETFs can help you save for the long run. Commodity ETFs can save you the trouble of physically purchasing anything from gold to coffee beans. Bond ETFs can give you exposure to a whole basket of bonds.
With just a few clicks on a computer, you can gain access to almost any type of investment using ETFs.