AUTHOR: DALE ROBERTS, CUTTHECRAPINVESTING
Exchange traded funds (ETFs) are one of the greatest breakthroughs for investors in the history of wealth creation, thanks to their accessibility for new investors and typically lower fees than a mutual fund1. High fees can be wealth destroyers.
The greatest favour you can do for yourself, in my opinion, is to check on the fees that you pay for your investments and the fees you pay to any advisor. In my view, you should not hand over a disproportionate amount of your wealth on an ongoing basis.
What is an ETF? It’s all there in the name. It is a fund that trades like a stock. ETFs are available on a stock exchange. Just as you might buy Apple stock on an exchange, you can purchase an ETF that buys the ‘whole stock market’ for the United States. For example, you can enter one ticker symbol and buy 500 of the largest (and well-known) companies in the U.S. And, you’ll be able to buy and own those great companies at a potentially lower cost. According to Morningstar Direct, F Class mutual funds charge an average management fee of 0.79%, while Canadian ETFs have an average management fee of 0.48%.
Building the ETF Portfolio
You’ve likely heard the investment expression, “Don’t put all of your eggs in one basket.” You want to own many baskets. The U.S. stock market is wonderful and home to some of the most vibrant and successful companies on Earth. But you may also want to own many Canadian companies, companies in Europe, Asia and around the globe. ETFs can make it easy to own those many baskets of stocks.
You can purchase an ETF that gives you access to the Canadian stock market, an ETF that holds European stocks, then Asian stocks, and on and on. Investors may build their portfolio around those Canadian, U.S. and international stocks (often called equities).
With an ETF, you can aim to achieve a diversified risk exposure by having an investment vehicle that has exposures across different companies, or perhaps regions. With a well-diversified ETF portfolio, you can own thousands of companies on all continents.
Here’s an example (for illustrative purposes only):
*Canadian stock ETF
*U.S. stock ETF
*International stock ETF
Managing the Risks of Stocks
Owning stocks makes you, essentially a part business owner, and is historically and arguably the greatest wealth builder. According to Goldman Sachs data from the past 140 years, the average U.S. stock market return for 10 years is 9.2%.2 But it’s not a straight line-up, and keep in mind, there is no guarantee of those generous returns. Past performance does not guarantee future returns.
Those companies trade on stock markets and the stock prices can fluctuate wildly at times. A stock ETF could potentially fall by 20%, 30% or even by 50% in a major correction. It can be quite the roller coaster ride at times – particularly following the 2020 pandemic market volatility, where we have seen wild swings.
Bonds Can Be Shock Absorbers
Bonds may help smooth out the ride for your portfolio. Bonds can work like shock absorbers as they have the habit of going up in price as stocks go down; bonds typically offer an inverse relationship to stocks.3 Of course, there is no guarantee of that inverse relationship, but bonds typically ‘do their thing’ to keep an eye on those volatile stocks.
ETFs can make it easy to add those bonds and potentially reduce the risk level of the portfolio. Investors can choose from Canadian bond ETFs, U.S. bond ETFs and international bond ETFs.
A potential portfolio asset allocation could include (for illustrative purposes only):
*Canadian stock ETF
*U.S. stock ETF
*International stock ETF
To reduce the risks, investors may also choose to hold a cash position4 plus some gold price and gold stock ETFs; holding cash and gold ETFs are typically viewed as safe haven strategies during economic downturns5. I even hold a small position in bitcoin as a portfolio diversifier.
Creating an ETF portfolio that matches your tolerance for risk is crucial.
Passive Versus Active Investing
When we write about buying the ‘whole stock market,’ that is a reference to passive investing. There are no arbitrary decisions based on what companies you might purchase and own. There is no analysis on what companies might be ‘better.’ With passive investing, the fund will simply buy the most valuable companies on a stock market. You own the biggest companies based on their value.
With active investing, a fund manager will do extensive analysis in the attempt to find companies that they feel offer the best investment opportunity and fit the investment objectives of the associated ETF.
There are passive and active ETFs. Active ETFs can typically have higher fees6, in my view, that can be money well spent at times.
You can build an ETF portfolio with passive or active ETFs. You might employ a mix of both styles.
The Canadian Robo-Advisors
If you want a managed portfolio and advice you can go Robo. A Robo-Advisor can give you access to comprehensive and globally diversified portfolios.
With a Robo-Advisor, you can complete everything online, from start to finish. If you want to talk to a real live human, no problem. Assistance and investment advice is available at all of the Robos. Financial planning is also available at a few of the Robo shops.
The most popular Robo Advisors are Wealthsimple, Questwealth (from Questrade), Justwealth, Nest Wealth, Smartfolio from BMO, ModernAdvisor and Invisor.
ETFs: How and Why?
Fees matter. ETFs may allow you to keep your fees as low as possible. I encourage you to do the research and gain the knowledge to be able to create your own ETF portfolio, or invest in one of the one-ticket portfolios.
To invest in ETFs, you would open a discount brokerage account and enter those ticker symbols to buy and sell. Top rated discount brokerages include Questrade, Qtrade, TD Direct Investing, National Bank Direct Brokerage and Scotiabank’s iTrade.
You can also reach out to the experts at Horizons.
1 F Class mutual funds charge an average management fee of 0.79%, while Canadian ETFs have an average management fee of 0.48%. Via Morningstar Direct as at November 18, 2020.
2 SP Global, as at July 15, 2020. https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/s-p-500-returns-to-halve-in-coming-decade-8211-goldman-sachs-59439981
3 NASDAQ, as at October 11, 2016. https://www.nasdaq.com/articles/price-correlation-between-stocks-and-bonds-2016-10-11
4 Yahoo Finance, as at July 21, 2020. https://finance.yahoo.com/news/cash-safest-asset-now-etfs-170005596.html
5 BNN Bloomberg, as at May 11, 2020. https://www.bnnbloomberg.ca/gold-etfs-luring-record-amounts-of-cash-despite-risk-asset-rally-1.1434593
6 Wealthtender, as at December 3, 2020. https://wealthtender.com/insights/investing/etfs/active-etf-basics-active-etf-expense-ratio/
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