Welcome to our beginner investor education program. This is the third of a six-part course on basic investing that we will publish every Tuesday. An advanced lesson plan appears every Thursday.
Exchange-traded funds, or ETFs, are booming. And no wonder: They offer an enticing combination of low costs, trading flexibility and diversification that appeals to many do-it-yourself investors.
Think of an ETF as a cross between a stock and a mutual fund. Like a stock, ETFs trade on a stock exchange. Like a mutual fund, ETFs invest in a basket of companies, usually an index such as the S&P/TSX composite or S&P 500. You can find more on the basics of ETFs here.
The biggest advantage ETFs have over mutual funds are the low costs. The iShares CDN LargeCap 60 index fund, for instance, tracks the 60 largest, most liquid Canadian companies, including banks, insurers, energy producers, gold miners, pipelines, retailers and utilities.
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It has a rock-bottom management expense ratio of 0.17 per cent, which means more of your money is working for you, instead of going into a fund manager's pocket. iShares offers a wide selection of ETFs, focusing on specific economic sectors, international markets, dividend stocks, real estate investment trusts along with various government and corporate bond indexes.
With competition in the ETF industry heating up, Canadian investors now have more selection than ever. Recently, Bank of Montreal threw its hat into the ETF ring, joining iShares, Claymore Investments and Horizons BetaPro, which caters largely to traders and speculators.
Just remember that, when you buy or sell an ETF, you'll pay a brokerage fee just as you would if you were buying or selling a stock. So if you plan to do a lot of trading, the expenses will add up. For people who plan to make regular contributions, index mutual funds - which have higher MERs but don't charge a fee for purchases - may be a better option.
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Investor Education:
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If you like the idea of setting up a portfolio and forgetting about it, ETFs are an excellent tool -- take a look at this article on the Couch Potato strategy.
Keeping up on all the new offerings in ETF land will make your head spin. As you'll see if you visit websites such as ETFtrends.com, ETFguide.com and IndexUniverse.com, the Internet has more information on ETFs than you could possibly hope (or want ) to digest.
My advice is to keep it simple. Find a low-cost ETF that invests in the Canadian market, another for the U.S. and perhaps a third that invests in an international index. For the latter two, if you want to reduce the volatility in your portfolio, you may wish to buy ETFs that control for currency fluctuations, such as the iShares S&P 500 index fund hedged to Canadian dollars .
Bond ETFs are also a good way to get exposure to fixed-income securities, with lower fees than bond mutual funds. Claymore and iShares offer several fixed-income ETFs, while Bank of Montreal has just a single government bond ETF. With bond yields at their lowest in years, keeping your costs to a minimum is more important than ever.
If you want low fees and instant diversification, ETFs are the way to go.
John Heinzl