Topic: ETFs

TSX ETF investing: 5 tips for successfully picking the right ones

Canadian ETFs

With all the TSX ETF investments available, it’s not too difficult to diversify your portfolio. Here’s how.

There are hundreds of ETF opportunities on the Toronto Stock Exchange (TSX) sponsored by investment managers like BlackRock Inc., BMO Asset Management and Horizons ETFs Management. The best TSX ETF investments represent a low-cost, tax-efficient way for investors to hold stocks. Investors get the broad market exposure of a traditional mutual fund, but with nominal fees and the ability to trade at will.

TSX ETFs trade on the stock exchange throughout the day, much like ordinary stocks. So you can buy them through a broker whenever the stock market is open, and generally you pay the same commission rate that you pay to buy stocks.


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Note, however, that even though you pay commissions to buy and sell TSX ETFs, they cost you less that mutual funds in the long run, because the MER (Management Expense Ratio) is generally much lower on ETFs than on those conventional mutual funds. That’s because most ETFs take a much simpler approach to investment. Instead of actively managing their holdings, they generally try to invest so as to mirror the holdings and performance of a particular stock-market index.

This is referred to as “passive” fund management, in contrast to the “active” management that conventional mutual funds provide at much higher cost. These ETFs passively follow the lead of whoever sponsors the index. Sponsors of stock indexes do from time to time change the stocks that make up the index, however, and they do tinker with the rules for calculating the index. ETFs then change their portfolio holdings to reflect these changes, without considering any impact the changes may have on the performance of the ETF portfolio.

Traditional vs. New TSX ETFs

The three paragraphs above refer to what you might think of as “traditional” ETFs, but there are also “new” ETFs:

A large number of those new ETFs use a conventional stock-market index as a base, but add their own refinements. This refinement usually aims to appeal to current investor trends or “hot” investment themes. It distinguishes the new ETFs from the older, plain-vanilla varieties that simply aim to mimic the index. It may attract attention in a crowded ETF field. If nothing else, it will justify a higher fee than the rock-bottom MERs associated with traditional ETFs.

In some cases, the new ETF improvement may provide an investment benefit, but it won’t do so consistently. Or it may hurt results, in the long run if not in the short. The worst cases are bad enough to turn investor profits into losses.

What you should know before buying TSX ETFs

To make the best use of ETFs, you should know both the advantages they offer, and some potential drawbacks.

Diversification is one of the most attractive features of ETFs. An investor could create an entire balanced portfolio solely from a few well-diversified ETFs.

As mentioned, ETFs are typically more tax-friendly and cheaper than other mutual funds or stocks. Here are several other important considerations to take into account before buying ETFs:

1. ETFs can be volatile, even with the diversification they offer.
2. Look at how broad the base of the fund is, so you can determine its volatility. The broader the ETF’s holdings, the less volatility it is likely to have.
3. The liquidity of ETFs you invest in.
4. Remember that ETFs are subject to capital gains tax just like individual stocks if held outside a registered retirement account.
5. You can run up commissions with frequent trading.

TSX ETF investing tip #1: Avoid “new” ETFs by sticking with “traditional” ETFs

As mentioned before, newer, theme varieties of TSX ETFs may attract attention—and sales—but they frequently carry higher MERs.

One sure result is that the higher MERs will cut into the value of your ETF portfolio every year.
Another drawback to the newer ETFs is how much easier it is for investors to act on an urge to invest in a specific stock or stock group without doing any messy, time-consuming—but necessary—research.

TSX ETF investing tip #2: Stay away from leveraged ETFs

Leveraged TSX ETFs aim to offer a two-for-one leveraged bet on the direction of oil prices and other commodities or index prices.

As a general rule, we advise against investing in leveraged ETFs, or anything that requires successful market timing. That includes short selling, options trading, or short-term trading of any sort. In all of these activities, it’s a rare investor who makes enough profit to compensate for the risk involved. That’s why we don’t suggest investing in these activities or any leveraged ETF.

TSX ETF investing tip #3: Pay lower Management Expense Ratios (MERs) by buying ETFs

As discussed, the MER is generally much lower on ETFs than on conventional mutual funds. The mechanics of ETF investing are just simpler and less active, which makes them less expensive to manage.

TSX ETF investing tip #4: Stay away from stop-loss orders

Market setbacks always revive investor interest in the stop-loss order—“stop” for short. A stop is an order to sell a stock if it falls to a price you choose. You can apply stops to TSX ETFs as well as stocks.

On average, up to a third of your stocks or ETFs drop after you buy, just from random fluctuations. Using stops will force you out of any of those investments that experience a temporary dip.

In deciding when to sell, it pays to consider all available information, not just price fluctuations. It’s extremely rare to meet investors who have improved on their investment results over long periods by using stops or any fixed rules on selling. These rules just ensure that you’ll do a lot of buying and selling and spend lots of money on brokerage commissions.

TSX ETF investing tip #5: Avoid using “hedged” ETFs

Consider a typical TSX ETF that gives you exposure to movements in an index of stock prices in an emerging market. This may appeal to investors who are thinking of investing in ETFs or other stocks in that market. But conservative investors may hesitate to buy, because they worry about currency movements in the emerging market. So the financial industry has come up with “hedged” ETFs.

The sales pitch is that you can profit from growth in the stock market of the emerging economy, but you avoid foreign-exchange risk because the ETF operator hedges against it. This conveniently overlooks the fact that it costs money to hedge.

Hedging costs will vary, depending on conditions in the foreign-exchange market, and on how an ETF carries out its hedging program. These fees can double or triple the typical ETF management fee.

You’ll need to dig deep to find out how much you pay for an ETF’s hedging feature. But you can be sure that the placing of each new hedge provides a profit opportunity for the ETF sponsor.

Summary: The best TSX ETF investments provide the best of both worlds

The best TSX ETFs offer well diversified, tax-efficient portfolios with exceptionally low management fees. Investors large and small can use ETFs to build well-diversified portfolios.

Is the simplicity of TSX ETF investing the best way to get returns, or do you prefer the more active management of mutual funds?

If you invest in new ETFs, how do you keep management fees from eating into your profits?

This post was originally published in 2017 and is regularly updated.

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