Many Canadians are still new, or even virginal, investors. I was too, until about 10 years ago, and we all have to start somewhere, don’t we? So how do you know what to buy or what not to buy? Well, that is the question, isn’t it? When I started out, I paid my bank every month to invest in a mutual fund for me, this was just as I was getting started, learning the ropes and doing my research. As I learned more though I was quite horrified to realize the costs I was paying for said mutual funds.
What is a mutual fund and why is it so costly you may be asking? Well, a mutual fund comprises a variety of individual stocks, bonds, or other securities chosen by a fund manager. The objective of the fund is to generate returns for investors while managing risk. Investors incur a Management Expense Ratio (MER), typically around 2%, to cover management, marketing, and administrative costs.
Now, 2% doesn’t sound like much, granted. But let’s put it this way. If you are putting away $500 a month into mutual funds, $10 of that goes into the fees. Say you start when you are 30 and will invest through to your retirement at 65. You will retire with a nice sum of $716,416.93 if your average interest is a modest 8%, that’s after paying your MER of 2%. We’ll come back to this number.
Hop to the new(ish) kid on the index block, Exchange Traded Funds (ETFs) which are becoming much more popular due to their increased focus on investment costs and fee transparency. ETFs typically have lower fees compared to mutual funds, e.g. 0.05%.
Let’s jump back to our example, if you invested the same $500 per month in ETFs, for the same time period and the same interest of 8%. You would retire with a whopping $1,140,968.93. That’s a difference of $424,552, yup, almost $425K.
That 2% has suddenly become rather substantial and very personal when we’re talking about your hard-earned money. Let’s invest in ETFs then!
Well, before opting for ETFs, it’s essential that you understand key aspects of them so you can make informed financial decisions.
ETFs contain investments that usually mirror an index, commodity, bonds, or a combination of assets. Unlike actively managed mutual funds, which aim for higher returns, ETFs aim to closely mimic the return of the tracked asset, with a small MER (e.g. 0.05%).
Each ETF is traded like a stock on the exchange, with its own ticker symbol. You have the flexibility to buy and sell to your heart’s delight, although I hope you’re just buying and holding! This differs from mutual funds, which can only be traded at the end of a trading day, and only by your fund manager who trades the holdings within the fund.
The creation of ETFs has roots in Canada. While an initial attempt in Chicago failed in 1989, the first successful ETF was launched on the Toronto Stock Exchange in 1990. This led to the proliferation of ETFs in Canada and inspired similar initiatives globally. Yay, Canada!
According to The Investment Funds Institute of Canada (IFIC), Canadian ETF net assets surpassed $403 billion by February 2024[1], marking a significant increase over the past years. Because of this popularity, the number of ETFs has also surged, with over 1,100 ETFs and 40 sponsors reported in February 2024—you’ve got a lot of choice. Despite holding a smaller market share compared to mutual funds, ETFs have consistently outsold them, perhaps because we’re all becoming more informed and are starting to take control of our money.
Here are a few advantages of ETFs:
1. Lower Fees: ETFs generally have lower fees compared to actively managed mutual fund—as per my example earlier.
2. Returns: Studies show that actively managed funds often underperform, partly due to higher fees and because the managers are buying and selling, instead of buying and holding.
3. Diversification: ETFs offer diversification across various assets and countries, reducing risk. They also allow customization of holdings based on risk tolerance and financial goals.
If you can think of any others, I’d love to hear from you below!
While ETFs offer advantages, there are trade-offs. DIY investors benefit most from lower fees, but you should do lots of research as you start to build your portfolio. The growing variety of ETFs also demands thorough research before investment decisions. How has it performed over the past 5 or 10 years? What are the holdings? How are the assets in the fund weighted for industry diversification? Do your research!
Investing in ETFs requires careful consideration of your personal goals, time, and expertise but it can be a great way to diversify without having to purchase individual stocks, which is great for investors just starting out with limited funds and limited clue! Do your homework, take your time, and remember the very astute quote from Star Wars, “The future has many paths – choose wisely.”
[1] https://www.ific.ca/wp-content/themes/ific-new/util/downloads_new.php?id=29331&lang=en_CA