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 ETF fees. They are also very liquid.
Investors use ETFs in a variety of ways, and some investors work only with ETFs and no other type of investment in portfolio creation.
An amazing aspect of ETFs is their diversity. Some investors may create an entire portfolio solely from a few well-diversified ETFs.
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.
Prices of ETFs are quoted in newspaper stock tables and online. You pay brokerage commissions to buy and sell them, but their low management fees give them a cost advantage over most mutual funds.
As well, 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 pay out to unitholders.
ETFs have a place in every investor’s portfolio, at TSI Network we also recommend using our three-part Successful Investor strategy:
- Invest mainly in well-established companies;
- Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
- Downplay or avoid stocks in the broker/media limelight.
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The best of these funds offer a diversified group of stocks and charge you low management fees. Here are five ETFs we like, and one we think you should pass on buying for now.
VANGUARD GROWTH ETF, $491.81, is a buy. The fund (New York symbol VUG; buy or sell through brokers) lets investors track the Center for Research in Security Prices U.S. Large Cap Growth Index. That broadly diversified index focuses on big U.S. firms.
Its top holdings are Nextpower (U.S. solar trackers), 11.8%; First Solar (China; solar panels), 11.7%; Sunrun (U.S.; panels), 6.5%; Enlight Renewable Energy (Israel; solar plants), 5.0; GCL Technology (China; polysilicon), 4.9%; ;and Enphase Energy (U.S.; home solar systems), 4.9%. The ETF’s MER is a relatively high 0.71%.
ETFs in brief
Exchange-traded funds are set up to mirror the performance of a stock-market index or sub-index. They hold a more or less fixed selection of securities that represent the holdings of that index or sub-index and will allow the fund to “track” its performance.
The MER (Management Expense Ratio) is generally much lower on traditional ETFs than on conventional mutual funds. That’s because most traditional ETFs take a much simpler approach to investing. Instead of actively managing clients’ investments, ETF providers invest so as to mirror the holdings and performance of a particular stock-market index.
ETFs practice this “passive” fund management style, in contrast to the “active” management that conventional mutual funds traditionally provide at much higher costs.
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Market-cap weighted indexes
The most popular method to construct passively managed ETFs is to aim to replicate a market capitalization-weighted index, such as the S&P 500 or the S&P/TSX 60. In the case of the S&P 500, the 500 largest U.S. companies by market value are included in the index. Individual stocks are weighted based on their market value.
Over the past 10 years, Toyota’s sales increased on average by 7.6% per year while profits increased by 10.8% per year. In line with this profit growth, the stock returned 11.1% per year.
The success of the company is attributable to a range of factors, including the following: