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What is an ETF?

Regina Financial AdvisorChris Worby a Trusted Regina Financial Advisor talks about ETF Mutual Funds: what they are, what they’re good for.

Every now and then someone asks me what an ETF is. I’ve been looking at them for a while and have noticed a few things about them.

First, a definition: ETF stands for Exchange Traded Fund. They come in a few varieties but the most important one is the index fund.

If you’ve been investing for any length of time, you’ve heard of the TSX, the S&P 500, The Dow Jones Industrial Average, etc. These are all indexes. They are set up to give a regular snapshot of a certain number of companies within that stock index. Let’s look at the TSX.

The TSX, for example, is the stand in for the Canadian stock market. It tracks 300 companies that are traded out of Canada. If you want to watch it minute by minute to see how the Canadian stock market is doing, you can. I wouldn’t recommend it though!

An ETF based around the TSX then, would be an Exchange Traded Fund (meaning a fund manager can buy into an index like any other stock) that is composed of the 300 stocks in the TSX in the same proportions represented there. It will mimic the TSX and on any given day, the return, positive or negative, of the TSX will be represented by that ETF.

So that’s what it is, what are the advantages?

Low fees. That’s the number one advantage to an ETF. Since there is no active management style associated with these funds  – only someone buying and selling to keep the ratios of companies about the same, the Management Expense Ratios (MERs) tend to be quite a bit lower.

Downsides. There are two major ones that I think of. First, if you need the guidance of someone to invest – and, frankly, everyone does when the market falls apart – these are low cost investment solutions that don’t come with active advice. That is an issue for many people and if you choose to invest in ETFs through banks or someone else, there will be an added layer of fees so the low cost becomes less applicable.

The second one is this. In my 13+ years in the business, I have seen indexes and managed money (mutual funds) side by side and during a dramatic drop – 2001, 2002, 2008, 2011 – I have noticed that the ETFs tend to drop further and faster than the actively managed money. Now, that is a blanket statement and not true of every mutual fund but, in general, managers tend to add value on the downside risk.

So that’s a quick primer on ETFs. If you have more questions, let me know.

Chris

 

December 4, 2014

Chris Worby is a Trusted Regina based financial advisor and Wealth Management services provider servicing local Regina households and businesses since 2001.

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