The beginner’s guide to investing in ETFs

If you’re a new investor with a small amount of money, it can be difficult to get started with investing.

There are a lot of choices, but you might not have enough to invest in it, or it might feel risky to put all your money in one investment.

ETFs are a popular solution for this conundrum. They provide a simple (and cheap) way for beginner investors to invest.

What is an ETF?

An ETF or Exchange Traded Fund is a collection (or basket) of stocks traded on the stock exchange. ETFs trade the same way as regular stocks.

The ETF might track (or replicate the returns) of an index, a commodity, or any other asset.

An ETF is essentially a basket of stocks (or other assets) owned and managed by a fund.

When you, the investor, buy a share of the ETF, you now own a portion of this basket of stocks.

Benefits of investing in ETFs

There are four main benefits of investing in an ETF:

ONE: Diversification

An ETF is like owning a small part of a basket of many stocks. It is a great way to get exposure to the broader stock market.

Rather than investing in only one (or a few) companies, with an ETF you own small portions of many companies. This way you are not at risk if one company goes down significantly.

TWO: Lower cost

Many popular ETFs are passively managed. This means that the ETF tracks the index and tries to duplicate the return of an index.

Here are a few popular ETFs that track an index:

• SPY which tracks the S&P 500
• QQQ, which tracks the NASDAQ

If you’re an individual investor, you get to own a part of each of the companies, without buying all the stocks.

This means that it costs you less to buy these shares in transaction costs, AND you don’t need as much money to own all the stocks to have a diverse portfolio.

THREE: Passive Income

Many ETFs pay out dividends, which can be a great way to build a passive income stream. The dividends would be from several companies, but you won’t have to purchase ALL the stocks of those companies individually.

FOUR: Hands Off Investing

if you’re just getting your feet wet with investing, or you simply have no interest in researching companies to invest in, an ETF is a great alternative!

You don’t have to worry about researching, keeping track, and stressing over specific companies, or stocks.

What to look for when purchasing an ETF?

Fees

ETFs, especially passively managed ETFs, tend to have lower fees than mutual funds. This provides an advantage to you as the investor by allowing you to access the same investments at a lower cost.

Fees can be as low as 0.1%, which is a lot lower when compared to mutual funds, which average about 2% in Canada.

Investing Style: Active or Passive

An ETF can be actively or passively managed.

A passively managed ETF is only trying to replicate the returns of the benchmark or index that it is tracking (not beat it).

For example, if you are invested in an ETF that tracks the S&P 500 (such as SPY), you can expect that the returns from the ETF will be identical to you investing in all the 500 stocks of the S&P (net of fees).

On the other hand, an actively managed ETF means that there is a portfolio manager that is frequently trading the stocks within the ETF.

The goal of an actively managed ETF typically is to beat the market index it is tracking.

Actively managed funds tend to be more expensive, as the fund manager is compensated for the active management. The jury is still out on whether actively managed funds return more than passively managed funds.

Some of the most popular actively managed ETFs on the market are the ETFs run by Cathie Wood, called Ark Invest.

Which index is it tracking?

Most ETFs have a mandate or are trying to replicate a specific stock market index or commodity. Knowing which index the ETF is tracking can be useful in understanding the types of holdings the ETF might have in the future, especially if you’re focusing on diversification strategies.

While you’re at it, you can also take a peek at the current top 10 holdings for that ETF to understand the type of stocks it holds.

How did it perform compared to the benchmark?

Now that you know which index the ETF should be tracking, it might be useful to compare the performance of the ETF against the index it is tracking (or the benchmark).

For example, if the index is supposed to track the S&P 500 but has consistently underperformed the S&P (after accounting for fees), it’s not doing a perfect job of tracking the index or replicating its return.

How to buy an ETF?

ETFs are traded on the stock exchange like other individual stocks. You can purchase ETFs through your brokerage account.

If you invest using a Robo-Advisor, like Wealthsimple, they invest in many ETFs, so you’re now likely invested in a basket of ETFs.

Brokerage accounts are typically offered through banks or online brokers, such as the big banks, WealthSimple, or Questrade in Canada.

They will typically charge a commission to trade the ETF, both when buying and selling.

One thing to consider when investing in ETFs is the type of account you purchase your ETF.

Canadian Specific Thoughts:

In Canada, broadly, you could have an account that is

• Registered as RRSP
• Registered as TFSA (tax-free savings account)
• Non-Registered account – no tax exemptions.

When purchasing an ETF in a brokerage account, it is important to understand the tax implications of your gains or losses.

For example, within the TFSA, capital gains are not subject to taxes, but US dividends are still subject to a withholding tax. If you hold an ETF that pays US Dividends, the TFSA is not a tax shelter for this investment.

Final Thoughts

An ETF is a great investment tool for beginners and for those who want to have a relatively hands-off strategy with their investments. While it may be a relatively passive investment, it is still important to understand how ETFs work and how they fit into your overall portfolio.