Exchange-Traded Funds (ETFs) aren't right for everyone. Here are some questions to ask before you decide to buy:
- Are you looking to buy and hold? ETFs are well suited to this strategy. On the other hand, if you buy and sell often, keep in mind that commission charges will start to reduce your true return.
- Are you looking for a way to reduce your investment costs? You may pay less to own an ETF than a mutual fund. Why? Since the ETF just follows an index, the fund manager doesn't have to do a lot of research about investing. Also, the fund changes investments only when the matching index changes. This doesn't happen very often, so there isn't a lot of buying and selling.
- Is your goal to participate in the long-term gains of the stock market? ETFs are a good way for many people to be in the market over time.
- Do you want to create a good mix of investments you won't have to watch every day? When you buy an ETF, you put your money in the same group of investments that an index follows. This means your results don't depend on one investment. You get even more of a mix if you choose ETFs that invest in different industries or different types of investments.
Example: You can spread your money across ETFs that cover a mix of stock market, bond and other indexes. This diversification will tend to smooth out the ups and downs of investing in just one type of investment.
- Do you want to build up your portfolio with a particular investment type or market sector? With ETFs, you can pick an index that targets that investment type or sector. For instance, if you want to invest more in bonds, you can choose ETFs that follow the Canadian bond market. If you want to invest in technology stocks, you can choose an ETF that follows that sector.
In most cases, you know exactly what the fund holds. This is not the case with mutual funds. The specific investments that a mutual fund holds can change any time, and its results may vary from those of the index.
Are ETFs a good choice for me at my stage in life?
Even if you answer yes to all these questions, ETFs may still not be the right choice for you. It depends in part on your stage of life and your investment strategy. Some people, for example, don't like having to track ETF cash distributions or worry about how to reinvest them. They also don't like the ongoing commissions and sales fees they may have to pay. Instead, these investors buy low-cost index mutual funds that reinvest their distributions automatically, free of charge.
Here's a quick review of how ETFs could fit into your investment portfolio if you are:
- In your early investing years (20s and 30s)
- In your peak earning years (40s and 50s)
Content in this section is provided in partnership with the Investor Education Fund, a non-profit organization promoting financial literacy to Canadians. To find out more go to GetSmarterAboutMoney.ca.