Everything you need to know about ETF investing

Exchange-traded funds (ETFs) can be a great investment vehicle to diversity your portfolio. They’re similar to mutual funds, but trade like stocks.

This primer provides details about investing in this popular vehicle ETFs. So, share it with your client before you start investing for them.

Is it smart to invest in ETFs?

ETFs are simple and offer diversity. Unlike individual stocks, they are made up of a group of stocks. So, buying one ETF exposes you to multiple stocks.

You can buy and sell ETFs throughout the stock market’s trading day. Many are highly liquid with substantial trading activity. Some capitalize on trends, such as the now-popular environmental, governance, and socially responsible invested funds. The competition means there are a lot to choose from.

Are ETFs safer than stocks?

When you buy a stock, you’re investing in a single company. So, when that company does well, your stock price – and investment value – increase. When the company does poorly, so does your stock and investment.  increases and so doe the value of your investment. When you buy an ETF, you buy a collection of stocks, so that spreads out your risk and is usually considered safer than buying an individual stock.

How do ETFs make money?

You can make money with an ETF through capital gains and dividends. ETF share prices can increase or decrease, impacting the fund’s value. Capital gains are simply increases or decreases in share prices.  Some ETFs can also pay dividends, or cash, to investors who hold the share.

How long should you hold onto an ETF?

The stock market traditionally goes up over time. So, your chances of making money in the stock market are greater if you hold your investments. So, don’t actively trade your stocks. If you hold them for years, you will usually gain more in the long-run. Your financial advisor can guide you on when to buy and sell Canadian ETFs and those from other places as well.

Can you lose money in an ETF?

You can – as stocks go both up and down. But, work with your financial advisor to minimize your investment’s volatility in ETFs Canadian and otherwise.

What are the gains and risks of ETF investment?

GAINS

1. Start investing: You can build a diversified portfolio with less capital than it might take with other investment vehicles.
2. ETF liquidity:  Most ETFs are very liquid and can be traded throughout the day. Mutual funds are only priced at he end of the day. Full-day trading means your advisor can help you exit a losing investment quickly to preserve your capital.
3. Low ETF fees: ETFs (generally have lower expense ratios than mutual funds.
4. Investment management choice: ETFs allow you to manage this investment in either an active or passive manner. Passive management involves building a portfolio to mimic a market index. Active management entails a much more hands-on approach and selecting stocks or sectors to “beat the market”.
5. Keeping up with trends through ETFs: One of the main reasons ETF investments are becoming more popular is that their issuers have been on the leading edge of introducing new and innovative products. These days, environmental, social, and governance funds are very popular, so it’s easy to find an ETF in them.

RISKS

1. Underlying fluctuations and risks: ETFs are like mutual funds: it depends on the companies in them as to how volatile they are. So, just because you have several companies in one fund, you can mitigate your risk – but not completely avoid it. The potential for large swings will depend on the fund’s scope. An ETF that tracks a broad market index, such as Standard & Poor’s (S&P) 500, is likely to be less volatile than one that tracks a specific industry, such as oil.  
2. Fees: Every time you buy or sell an ETF, you pay a fee. Those can quickly add up and reduce your investment’s performance. No-load mutual funds are sold without a fee, or sale charge, so some find them advantageous compared to ETFs. If you’re deciding between similar ETFs and mutual funds, check out their different fee structures, including trading fees.
3. ETF expense ratio: The expense ratio is a measure of what percentage of a fund’s total assets are required to cover its operating expenses each year. This isn’t the same as a fee that you pay to the fund, but it has a similar effect: the higher the expense ratio, the less return you get. ETFs are known to have very low expense ratios relative to many other investment vehicles. Compare before you buy.
4. Lack of liquidity: The biggest factor in buying an ETF or stock that’s traded publicly is its liquidity, which means you can get out of it relatively quickly without the price changing. If an ETF is thinly traded, there can be problems getting out of it, depending how much you have in it. The biggest sign of a non-liquid investment is a large spread between the bid and ask. Ensure the ETF is liquid before you buy it, so study the spreads and market movements before opting in.
5. Capital gains distribution: Sometimes an ETF will distribute capital gains to shareholders. That isn’t always great if you’re an ETF holder as you must pay capital gains tax. It’s usually better if the fund invests them rather than distributing them and creating a tax liability for you. Investors usually want to reinvest the capital gains distributions, which means you need to return to your broker to buy more shares and pay new fees.
6. Lost taxable income control: If you buy shares in a pool of different stocks you have more flexibility than if you buy the same group of stocks in an ETF. That means that you have less ability to control tax loss harvesting. If the price of a stock declines, you can sell shares at a loss and reduce the total capital gains and taxable income to a certain extent. You don’t have the same luxury if you hold the same stock through an ETF. The ETF determines when to adjust its portfolio you must buy or sell the entire fund rather than individual names in it.
7. Control issues: One of the reasons why ETFs appeal to many investors is also one of its limitations since you don’t have a say in the individual stocks that are in an ETF’s index. If you want to exclude a stock for ethical reasons, you can’t slice it off from the others, so need to decide if you’ll keep or forego the fund.