Topic: ETFs

How to Pick a Top ETF Investment

Bank of Montreal

A top ETF will practice “passive” management, and have a much lower MER than a comparable mutual fund.

You might say we specialize in “plain vanilla” stocks—the ordinary kind, in other words, without any special features. We always almost stay out of new issues. For the most part, we also advise against trading in options and futures. One investment innovation that we do recommend is the exchange-traded fund, or ETF. But ETFs are unlike other investment innovations; they aim to simplify your investing, rather than complicate it.

A top ETF investment can be a great low-fee way to hold shares in multiple companies with a single investment.

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A top ETF will not participate in trying to “beat the market” or in market timing

Of course, we stay out of ETFs that use leverage, or that aim to somehow “beat the market” or try and time the market

We’ve found that our exclusionary rules leave us plenty of scope for sound investing, with lots of high-value opportunities and few surprises. In investment innovations, surprises tend to be unpleasant. That’s because innovations aim at selling more “product” (as brokers say) to investors, rather than raising investor returns. In fact, innovations may give you greater stability, steady income or tax deferral, but you generally pay for these advantages out of total investment return.

A top ETF investment practices “passive” fund management

The best ETFs practice “passive” fund management, in contrast to the “active” management that conventional mutual funds or some new ETFs provide at much higher costs. Traditional ETFs stick with this passive management—they follow the lead of the sponsor of the index (for example, Standard & Poors). Sponsors of stock indexes do from time to time change the stocks that make up the index, but generally only when the market weighting of stocks change. They don’t attempt to pick and choose which stocks they think have the best prospects.

This traditional, passive style also keeps turnover very low, and that in turn keeps trading costs for your ETF investments down.

We think you should stick with “traditional” ETFs.

A top ETF investment includes the following characteristics:

  • Diversification: 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.
  • Tax and cost efficient: ETFs are typically more tax-friendly and cheaper than comparable mutual funds.
  • Lower MERs: The MERs (Management Expense Ratios) are generally much lower on ETFs than on conventional mutual funds. That’s because most ETFs take a much simpler approach to investing.
  • Low turnover for index ETFs: Shares are added or removed when the underlying index changes. But with ETFs, you won’t incur the regular capital gains taxes generated by the yearly distributions most conventional index mutual funds pay out to unitholders.

Top ETFs rarely rely on active management

Actively managed ETFs use a conventional stock-market index as a base, but add their own refinements. These refinements are tailored to current investor preferences or prejudices. That’s distinctly different from the traditional ETF, which simply aims to mimic an index. These newer, theme varieties may attract attention—and sales—but they frequently carry higher MERs.

In some cases, these newer ETF may provide investment benefits but not consistently. In fact, it may hurt results in the long run. The worst cases are bad enough to turn investor profits into losses. One sure result is that the higher MERs will cut into the value of your ETF portfolio every year.

The wrong ETF investments can eat away at your profits. Have you fallen for a “new” ETF only to find out it wasn’t performing as you hoped?


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