It seems like everyone is saying “Buy ETFs.” But what are ETFs? How are they different from mutual funds? Many people don’t know that ETF stands for Exchange Traded Fund. That can make it even more confusing because if someone advises you to buy a “fund” it’s not immediately clear whether they mean a “mutual” fund or an “ET” fund. Here’s some info to help
sort through the confusion.
ETFs are a Hybrid of a Mutual Fund and a Stock
Like mutual funds, most ETFs are a pool of money that is invested in shares in a variety of companies or in a portfolio of other investments. One ETF might hold shares in all large companies listed on the TSX that pay dividends. Another ETF might hold physical gold, silver, platinum and other precious metals. A third ETF might hold short term-to-maturity bonds issued by various corporations. Usually ETFs do not hold only shares in one company or only one type of investment.
ETFs Offer Diversity
Like mutual funds, ETFs offer an investor diversity. By pooling money with other investors in an ETF before buying assets an investor can buy a small amount of many different financial assets. For example, for $100, an investor might be able to buy units in a fund that is invested in 100 companies. The investor couldn’t buy a share directly in each of those 100 companies with only $100 to invest. The same benefit is offered by a bond ETF.
ETFs Are Traded on Stock Exchanges
Unlike mutual funds, ETFs are sold on as discrete units on stock exchanges. Just like you can buy a share in Suncor, you can buy a unit in the BMO Canadian Dividend ETF. You cannot usually buy fractional units, just like you cannot usually buy fractional shares. Like shares, you can buy one unit of an ETF or 100,000.
How Are ETFs Priced
The price per unit for an ETF can jump up or down all day just like it can for anything listed on the stock exchange. Mutual fund orders are filled at the price of a unit of the fund set at the close of the trading day based on the value of the assets held by the fund. You don’t actually know what price you will be buying or selling a mutual fund for when you place your order. You do know what price you will be paying for an ETF, if you set a price limit on your order to buy or sell.
ETFs Purchased and Sold on Stock Exchanges are Commissionable Trades
In general, you will pay a trading commission to buy (or sell) a unit or units of an ETF listed on a stock exchange. For example, if you have a self directed investing account with InvestorLine and if you are eligible for Flat Fee Pricing, you will pay $9.95 for each filled purchase or sale order of an ETF.
At the time this was written, Questrade a discount online brokerage company was offering clients free (no fee) ETF purchases. They only were charging a fee to sell ETFs.
Also at this time, Scotia iTrade, another online brokerage, was offering fee-free purchases and sales of 50 ETFs including some funds offered by iShares, Vanguard, Powershares and Horizons.
QTrade and Virtual Brokers may also offer some commission-free ETFs although not all ETFs are zero commission.
Are There Minimum Purchase Amounts for ETFs
In general, there are no minimum purchase requirements for ETFs purchased through a brokerage account from the stock market. The commission you have to pay to make a purchase, however, may make you think twice about buying an extremely small number of units. For example, if a unit is priced at $28 and you have to pay $9.95 to buy units, you may decide you only want to buy when you can afford several hundred dollars of investment.
Can I Buy ETFs Directly from the Issuer?
Generally speaking, you can’t buy ETFs directly from the issuer. Usually you have to buy them from the stock market directly or indirectly by buying them through a financial advisor.
Do I Have to Hold ETFs for a Minimum Time to Avoid Penalties?
Unlike most mutual funds, you do not have to hold ETFs for a minimum length of time. Many mutual funds charge a penalty if you sell them within 90 days of purchasing. ETFs can be sold as soon as they are purchased. You will usually pay a commission, however, on each purchase or sale of ETFs made through a brokerage.
Aren’t ETFs Index Funds?
Some of the first ETFs were index funds. They owned equities that matched those listed on specific indices. For example, an S&P TSX Composite Index ETF might hold the same companies that comprise the TSX Composite index in the same proportion.
These Index Fund ETFs were often offered for sale with very low management fees. For investors who don’t believe you can beat the market, these original index fund ETFs offered a simple way to buy virtually the entire market in one transaction with a low annual maintenance fee.
Most ETFs are not index funds anymore. And even if the name of the fund suggests it matches an index, you still need to review the fund in detail to see how it works. Names can be misleading. Nor are low fees guaranteed. You need to check the fees carefully and not just assume that they will be low.
Are ETFs Always Low Fee?
No. Many ETFs have very low management fees. However, each fund sets its own fee. Always check the details before you buy an ETF.
Do you own ETFs? Do you prefer index ETFs or do you use them to invest in specific sectors or asset classes? Please share your experiences with a comment.