Topic: ETFs

4 tips for successful investing in Canadian exchange-traded funds

canadian exchange-traded funds

Canadian exchange-traded funds are some of the best ETFs on the market

Canadian exchange-traded funds, otherwise known as Canadian ETFs, are great way for investors to own a wide range of stocks with a single investment. Canadian exchange traded funds are also eligible for the Canadian dividend tax credit, although this only applies to Canadian ETFs that pay dividends.

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So investors who are Canadian taxpayers, and who hold Canadian dividend ETFs, get a special bonus. Their dividends are eligible for the dividend tax credit in Canada. This dividend tax credit—which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.

This means that dividend income will be taxed at a lower rate than the same amount of interest income. Investors in the highest tax bracket pay tax of around 29% on dividends, compared to 50% on interest income. At the same time, investors in the highest tax bracket pay tax on capital gains at a rate of about 25%.

What is an ETF?

ETF is an acronym for exchange-traded fund. These exchange traded funds are used to track indexes as closely as possible, since it’s impractical for investors to buy an index outright.

Exchange-traded funds trade on stock exchanges, just like stocks. Investors can buy them on margin, or sell them short. The best exchange-traded funds offer well-diversified, tax-efficient portfolios with exceptionally low management fees.

Beware of buying vaguely described Canadian exchange traded funds

Canadian exchange-traded funds generally follow a well-defined index, such as the S&P/TSX 60 index. But be careful investing in Canadian ETFs that show wide disparities between the fund’s portfolio and the investments that the sales literature describes.

It’s often hard to find out much about who is making the decisions, what sort of record they have, and what sort of investing they prefer. We always take a close look at an exchange traded fund’s performance and its holdings to see if they differ from what the prospectus or sales literature would lead investors to expect.

Avoid buying Canadian exchange-traded funds with anonymous managers

This includes buying Canadian ETFs run by committees. The trouble here is that the brains of the fund may leave, and investors would never know it until they saw the drop in their ETF’s performance

Canadian exchange traded funds are less expensive

Compared to mutual funds, ETFs are less expensive to hold. ETFs give you a low-cost way to invest in a narrow market segment. That’s typically cheaper than investing in a mutual fund with a similar focus. With fees as low as 0.10% a year for ETFs vs. mutual fund companies that can charge you 2% to 3% or higher on their funds. ETFs can save you a lot of money and boost your returns over time.

Canadian ETFs trade on stock exchanges, just like stocks. That’s different from mutual funds, which you can only buy at the end of the day at a price that reflects the fund’s value at the close of trading.

ETFs also have low turnover. Shares are only added or removed when the underlying index changes. As a result of this low turnover, you won’t incur the regular capital gains taxes generated by the yearly distributions most conventional mutual funds payout to unitholders.

If you decide to invest in individual stocks, as well as Canadian exchange-traded funds, you should take care to spread your money out across most if not all of the five main economic sectors: Finance, Utilities, Consumer, Resources & Commodities, and Manufacturing & Industry.

ETF investing requires a long term mindset

Investors should take a long-term view of investing when deciding on Canadian exchange traded funds. They are units you will hold on to for a long time. Buying and selling them too quickly will generally result in minimal capital gains.

Are you currently invested in a Canadian exchange-traded fund? Has it been profitable for you? Share your experience with us in the comments.


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