ETFs 101
Exchange-traded funds (ETFs) can be a compelling investment choice for investors seeking trading flexibility and cost-effective access to a range of stocks or bonds. To make an informed investment decision, it’s important to first understand the basics.
What is an ETF?
An exchange-traded fund, commonly referred to as an ETF, is a type of investment fund that holds a collection of assets, such as stocks or bonds, and trades on a stock exchange, much like a single stock. ETFs are designed to offer investors a simple and cost-effective way to gain exposure to a broad range of markets or specific investment themes.
Passive, active and smart beta ETFs
ETFs can be classified into the following categories: passive, active, and smart beta.
- Passive ETFs aim to replicate the performance of a specific index, such as the S&P 500. These funds follow a rules-based approach and typically have lower fees because they don’t require active management.
- Active ETFs are managed by portfolio managers who make investment decisions based on research, forecasts and market conditions. These ETFs seek to outperform a benchmark rather than simply track it. While they may offer the potential for higher returns, they often come with higher management fees and may involve more trading activity.
- Smart beta ETFs offer a middle ground, generally employing rules-based approach like passive ETFs but with additional criteria to select investments. These criteria can be based on specific factors such as value, momentum, dividend yield, or volatility. Smart beta ETFs aim to enhance returns or reduce risk by targeting particular investment outcomes or “beta” exposures, thereby blending aspects of both passive and active investing.
ETFs vs. Mutual funds: What’s the difference?
Feature |
ETFs |
Mutual funds |
Trading method |
Traded on exchanges throughout the day, allowing intraday transactions |
Purchased or sold through the mutual fund company or broker at end-of-day NAV |
Holdings |
Holdings typically disclosed daily.1 |
Holdings typically published quarterly |
Minimum investment |
No minimum investment amount |
May require high minimum investment amounts |
Trading costs |
Trading costs paid by the buyer/seller; other investors typically not affected |
Trading costs shared by all holders, reducing net asset value daily (NAV) |
Expense ratio |
Typically, lower expense ratios |
Generally higher expense ratios |
Other fees |
Standard trade commissions plus bid/ask spread |
May include additional fees such as sales loads, trading fees, etc. |
Liquidity |
Available intraday |
Available at the end of the trading day |
Uncovering the benefits and risks of ETFs
Benefits |
Risks |
Lower cost and transparent fees: ETFs often have lower expense ratios than mutual funds. |
Execution risk: Improper trade types or lack of understanding can lead to less favorable outcomes, affecting returns. |
Accessibility and flexibility: Investors can purchase as little as one share and trade throughout the day. |
Fund closures: May lead to tax implications.
|
Broad market access: ETFs offer exposure to a wide range of investment strategies and global markets. |
Counterparty risk: Potential risk if the ETF or mutual fund uses derivatives. |
1The regulations surrounding disclosure can vary by country, and in Canada, ETFs typically provide holdings information on a monthly or quarterly basis.
Why choose ETFs?
ETFs can be suitable for a wide range of investors, from those just starting out to experienced portfolio builders. Ultimately, they are a more flexible investment tool, offering exposure to diverse asset classes with the ease and convenience of stock trading.
