What are ETFs?
Exchange Traded Funds or ETFs are a great innovation in the world of finance that can provide large exposure to a specific or not so specific segment of the market. An ETF is just like a stock, that means it is traded on a specific stock market during the day and can be bought using your favourite (or not so favourite) stock broker. Without entering into too much details on how they work and how they are built (that you can see here on iShares), the most popular ETFs are the “unmanaged” index ETFs. That means that the nice people running the ETF try to follow a specific index as closely as possible. An index can be the NASDAQ for example or the DOW, but many other index exist.
Some big players in the ETFs market are Vanguard, Blackrock iShares and Invesco, just to name a few. In fact, there is a great possibility that your financial institution issues ETFs that you can buy as well. My personal favourites are Vanguard and iShares, that’s why I will use a few of their canadian ETFs as examples but the same applies to US.
Why ETFs are Great?
They tend to charge a lot less in management fees than their cousins mutual funds. In part because they simply follow an index rather than trying to beat a certain index. Beating an index can mean a lot of research and market timing by pros. It can also mean you will pay big bucks in the hope that they will be able to give you a better percentage increase than the index. ETF is also a great choice for market exposure and long term investing like you should do as an average Joe trying to work his way to retirement. But even more if you are into Financial independence like me.
Here is a look at what might contain an ETF (from the iShares website):
This is a really popular Canadian stock market ETF from iShares (TSE:XIC). It follows the entire canadian stock market! I bet you could not get that much exposure on your own (unless you’re worth more than a million maybe!). Again, that is the point, you will reduce the risk by owning the entire market instead of just a collection of 10-15 stocks which might already be a challenge to manage if you’re not a professional.
Basic Fund Information
If you scroll down on the page on the iShares Website, you can have more information like a quick and easy way to know what you’re looking at investing into.
While building a portfolio, that might help you decide if you want to invest in that segment or not.
More technical data can include performance like illustrated below but that does not reflect what might happen in the future. Still, you can take it as a rough picture.
Key facts are technical numbers that can tell you quite a bit about the ETF you wish to invest in.
As a few examples:
- Net Assets: the amount invested in that ETF at the time of the snap shot.
- Exchange and BenchMark Index: which stock exchange it’s trading on and which benchmark it’s trying to follow.
- Units Outstanding: the number of shares of this ETF are on the market for trade.
- CUSIP: the identifier of the fund.
- Management Expense Ratio or MER: really important, that’s what the ETF will cost you, as you can see here it is 0.06% which is really good!
- Asset Class: this tells you if you invest in stocks (mostly Equity), fixed income (Bonds or the like), REIT (Real Estate Investment Trusts) or other vehicles.
- Number of Holdings: the number of securities (stocks, bonds or the like) it contains.
- Price: how much you expect to pay for a unit of this ETF.
Portfolio characteristics is detailed information that you might want to look at before buying as well. You can refer to the iShares Website for this information, click on the “!” icons to know more about a certain characteristic.
iShares and Vanguard have a risk rating indicator that can give you a rough idea of how much risk this investment involves.
Still in TSE:XIC, if you scroll down a bit you will see the list of holdings. They indicate what the portfolio holds and at which ratio. For example in the image below, they hold Royal Bank Of Canada at 6.81% of the asset mix. That would mean that out of your 1000$ you invest in there for example, you would get 68.10$ of Royal Bank Of Canada’s shares.
This section gives you a better idea of the sectors and area in which you are investing. Depending on your strategy, that might influence your choice. For example if you think you have enough money in the financial sector or in a certain country, you might want to consider another fund.
Last but certainly not least is more interesting stuff you should really read before investing. That will give you more information than what is on the Website. Fact Sheet is a must read.
Note: most ETFs Websites contain the same kind of information I just shown above.
They are not Traded like Mutual Funds
You cannot trade parts of ETFs like mutual funds because of the way they are built. You need to buy whole shares. In other words, with a Mutual Fund if I want to buy 1000$, I can buy exactly that amount. With ETFs you must buy shares at for example 24.50$: 1000$/24.50$ = 40.82. I have 0.82 of a share that I cannot buy with 1000$ and I need to take the trading fee into account as well. My transaction will be: 980$ + 9.95$ (if the fee is 9.95) for 40 shares of that particular ETF. As you might have noticed, the fee being constant, the more I buy the less it matters.
What is to Remember
Building a portfolio is in part about managing risk and ETFs can help lower the risk a bit (depending on where you invest your money) by giving you exposure to entire segments of the market. Again it’s recommended to plan investing for 10 years or more to help lower the risk of market crashes. Another big advantage of ETFs is that they are cheap most of the time compared to mutual funds, they can also be traded during the day like stocks which can be convenient as well!
Disclaimer: please keep in mind that investing can be risky, you could even lose your capital. Rebalancing helps mitigate the risk but does not remove it. I cannot be held responsible for what you do with your money. Invest wisely by gathering information and talking to an advisor if you don’t feel comfortable.