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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.

Related Reading

The Types of Mutual Funds, Why They’re Good, and Quick Buying Tips

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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.

I noticed on a chat board recently that some people do not understand how GICs work. They wanted to know if they could cash their GIC at any time to pay a bill, buy a car, or re-invest somewhere else at a better rate. In short, they wanted to cash their GIC before it matured.

How Do GICs Work? What Is Agreed Between the Issuer and the Buyer?

True Guaranteed Investment Certificates are not bank accounts or cashable term deposits. The issuer is selling the buyer a guaranteed return of their money plus the agreed on interest at the maturity date.

For example, a bank might sell a client a $2000 GIC with an interest rate of 2.3% per year that matures in 2 years. That 2.3% interest rate is higher than what the buyer could earn by putting the money in a bank account or a cashable term deposit at that specific time.
These standard, regular or true GICs cannot be cashed before they mature. You’re agreeing to lock in the money for the term to maturity.

What if Interest Rates Change After Buying a GIC?

If interest rates drift lower, the GIC buyer has guaranteed a good interest rate for two years. If interest rates rise, however, the buyer has locked in their money for the term to maturity at what may now be a lower interest rate. In the first case, it’s great! In the second case, it’s tough.

Standard GICs Cannot be Cashed without the Consent of the Issuer

A regular GIC is a fixed term contract. It cannot be cashed. You can’t get your money out before the maturity date, even if the interest rates have changed, or you have lost your job, or you want to get married.

The President’s Choice Financial “Must Have” GIC is an example of this. It clearly states that the GIC is “non-redeemable and must be held till maturity.” (http://www.banking.pcfinancial.ca/a/products/gic.page?region=ON&language=en&signinop=OB)

You Don’t Have to Buy a Standard GIC

If you aren’t sure whether you will need the money early, consider alternative types of investments. ING Direct GICs are all Cashable GICs. If you need to cash them before maturity, you will get back all of your principal and you may get a small “early redemption interest” payment as well depending on how quickly you cash it after buying it.
(http://www.ingdirect.ca/en/save-invest/gic/index.html)

Most banks offer some type of GIC that can be cashed. These GICs might not offer the length of time you want to invest for, or may only offer a much lower rate than a regular GIC, or they might limit when you can cash them early, or they might charge a fee for cashing early. You really have to read the details for each product you are interested in.

You Can Cash a GIC Early if the Issuer Agrees

The exception is you can cash a standard GIC early *IF* the issuer agrees.

For example, when we bought our first house, our RRSP investments were in GICs. Some of them were in the middle of the term and not ready to cash. Fortunately, we were getting our mortgage from the same bank that held our RRSP GICs. They readily agreed to let us cash the GICs early, without a penalty, so we could withdraw the money under the Home Buyer’s Plan and use it for a down payment.

Paying a Penalty to Cash a GIC Before It Matures

Some issuers will allow you to cash out a GIC early for a penalty.

“Extraordinarily nice” institutions might allow you to get your principal back and some of the interest. ING Direct offers this type of GIC.
“Nice” institutions might give you back your initial cash but not give you any interest. This is not uncommon in the case of a severe unexpected financial problem such as a death.
“Regular” institutions will not pay you any interest and will penalize you part of your original investment. So if you paid $1000 for your GIC they may only give you less than $1000 back.

Re-Selling a GIC Before It Matures

In theory, what the financial institution does when it cashes a GIC early is it looks for someone to buy it. Usually, they will have to sell the GIC at a discount to get someone to buy it. So if it was a $1000 GIC paying 2% interest at the end of a 1 year term (and therefore worth $1020 when in matures) they may have to sell it for $900 to find someone who will buy it.

Only GICs which are transferrable and assignable can be re-sold. Most standard, regular, true GICs aren’t.

In general, you can’t re-sell a GIC yourself. The issuer would have to agree to the sale and most won’t.

What Can You Do If You Need Cash and Your GIC Is Locked Up?

You might be able to ask a friend or relative to loan you the money with a written agreement that on the day the GIC matures you will collect the principal and interest and pay them back. Even if they are good friends, you should give them a promissory note in writing, preferably witnessed by a non-friend. That would mean they could easily take you to court and win if you didn’t pay them back. But since you’re going to pay them back, that would be ok, right?