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Understanding ETFs
Whether you’re investing on your own or working with a financial advisor, our TD Exchange-Traded Funds (TD ETFs) can help you lower costs and increase your return potential.
What is an ETF?
Exchange-Traded Funds (ETFs) are investments that seek to combine the diversification of mutual funds with the trading flexibility of securities.
Like mutual funds, ETFs invest in a basket (i.e. portfolio) of securities such as stocks, fixed income or commodities. But, unlike mutual funds, ETFs are bought and sold on a stock exchange. This means their pricing changes throughout the day. In contrast, mutual fund prices are determined daily after the close of the stock market. Additionally, mutual fund purchases and sales are processed by the fund company.
What are the potential benefits of ETFs?
Core benefits include:
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Diversification: Through a single ETF, investors can gain instant diversification to a portfolio of different securities. Holding a mix of securities that have a low correlation (i.e. do not behave in the same way) may potentially stabilize the performance of an ETF and your investment portfolio. Equally important, diversification can help minimize the risk of loss – if a few investments perform poorly, others held in the portfolio may be doing better.
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Transparency: The holdings inside an ETF are published daily on the issuing company's website. Investors will know exactly what they're invested in. This can help you diversify your portfolio - i.e. avoid owning duplicate investments. Or, if you're invested in an index ETF, you can easily see how closely it mirrors the benchmark index it's designed to replicate.
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Trading flexibility: Since ETFs are listed on stock exchanges, investors have the flexibility of buying and selling them when the market is open. Investors can exercise some control on the price they get – for example, by placing a limit order (an order to buy/sell a security at a specific price or better). Finally, with ETFs being listed on exchanges, investors can access ETFs across the globe – they are not limited to ETFs from Canada.
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Lower costs: Compared to other investment funds, ETFs tend to have lower management fees and operating costs. Lower fees mean more of your savings are invested which - with the benefits of compounding – can improve your return. However, as ETFs are bought and sold on an exchange, remember there can be brokerage commissions charged for each transaction.
ETFs vs. Mutual Funds vs. Stocks - What are the differences?
The table below shows the basic similarities and differences between ETFs, mutual funds and stocks.
Mutual funds |
ETFs |
Stocks |
|
---|---|---|---|
Underlying Securities |
Securities, fixed income, commodities, currency, derivatives. |
Securities, fixed income, commodities, currency, derivatives. |
None |
Diversification |
Yes |
Yes |
No |
Pricing |
Price is calculated at the end of day. It's based on the market value of the investments in the fund divided by the number of units outstanding (i.e. Net Asset Value Per Share - NAVPS). |
Based on the bid and ask prices. Bid is the highest price investors will pay to buy it. Ask is the lowest prices investors will sell it. Prices change throughout the market trading day. |
Based on the bid and ask prices. Bid is the highest price investors will pay to buy it. Ask is the lowest prices investors will sell it. Prices change throughout the market trading day. |
Eligible for pre-authorized contribution plan "PAC"3 |
Yes |
No |
No |
Management Expense Ratio |
Mutual funds charge a management fee and have certain operating costs, for the ongoing operation and administration of the fund. Together, these fees make up the management expense ratio (MER), which is the total of the management fees and operating costs expressed as a percentage of the fund's total assets. |
ETFs charge a management fee and have certain operating costs, for the ongoing operation and administration of the fund. Together, these fees make up the management expense ratio (MER), which is the total of the management fees and operating costs expressed as a percentage of the fund's total assets. |
None |
Management fees |
Often between 1% to 3% |
Typically lower than 1% |
None |
Transaction costs/fees |
Several purchase options, some do not incur commissions. No commission charged on selling mutual funds. |
Brokerage commission charged on buying and selling ETFs. |
Brokerage commission charged on buying and selling stocks. |
Rebalancing costs |
Typically no costs to switch between funds. |
Brokerage commissions (but typically less expensive than stocks). |
Brokerage commissions on additional stock purchased or sold to rebalance portfolio. |
Distributions |
Distributions and interest income can be automatically reinvested at no additional costs through a dividend reinvestment plan (DRIP). |
Distributions and interest income can be automatically reinvested through a DRIP, provided total distributions are enough to purchase a whole ETF unit. |
Distributions and interest income can be automatically reinvested through a DRIP. Depending on the stock, total distributions do need to be enough to purchase a whole unit - a fraction of the share can be purchased. |
Understanding active vs. passive management
With actively-managed ETFs, the Portfolio Manager picks securities based on their research and strategies. They seek to own a basket of securities that is different from an index in an attempt to outperform the index.
For passively managed ETFs, the Portfolio Manager seeks to hold a basket of securities similar to the benchmark index it's attempting to replicate. For example, the ETF would seek to hold a similar basket of securities as the S&P/ TSX Composite Index or the Dow Jones Industrial Average Index.
What's the difference between Index Funds and ETFs
This question is raised frequently by investors and it's easy to understand why – the two investment solutions can be similar in some ways.
Index Funds are mutual funds that typically track a specific market index such as the S&P/TSX Composite Index. Broad-market ETFs also do the same. For both investments, the Portfolio Managers attempt to create a portfolio of securities that replicate the composition and performance of a given index (i.e. passive management).
Where the two differ is in the costs, and how they are bought and sold. As Index Funds are mutual funds, they can have higher fees than ETFs. And while mutual funds are purchased and sold through the issuing investment management company, ETFs are traded on stock exchanges.
Buying and selling ETFs can involve brokerage transaction fees, while purchases and redemptions of Index Funds are less likely to incur fees.
How do you buy ETFs?
Since ETFs are listed and traded on stock exchanges, they can be bought and sold through a direct investing brokerage or an advisor.
To invest in ETFs, you'll first need to open an account. Remember, you can hold ETFs in a tax-free-savings account (TFSA), Registered Retirement Savings account (RRSP), and non-registered accounts. The tax consequences for holding ETFs in each type of accounts will vary. Speak to an advisor or a tax specialist for more information.
Several types of direct investing services are available. You can speak directly on the phone to a representative, who can help you place an order for a flat fee. You may also have the option of placing the order yourself online, often for a lower flat fee.
TD Direct Investing offers both telephone and online services – Access TD Direct Investing website.
Alternatively, you can also invest in ETFs through an advisor. While this approach will include advisory fees and/or commissions, it may be worthwhile if you need guidance on selecting the right ETFs for your overall portfolio. Remember, a diversified mix of multiple securities can help you achieve your investment goals with lower risk. Learn about TD Wealth – personalized planning and advice.
1 16 amazing things invented by Canadians, CBC News, Posted Jul. 10, 2017, Tracey Lindermand.
2 The Exchange Traded Fund Manual, Second Edition, John Wiley & Sons Inc., 2010, Gary Gastineau.
3 A simple automatic plan that transfers money from your bank to your investment account to purchase units on a regular basis.
The above information about the Tax-Free Savings Account is based on the information currently available from the Canadian government. To learn more or to check for updates, visit the TFSA information page on the Canada Revenue Agency website.
Not all ETFs are created equal. The TD ETF lineup is built with this in mind.