Purchasing ETFs in Canada: Why are ETFs So Popular?

Buying ETFs in Canada is simple. You open a brokerage/investment account. Deposit some money. Whenever it’s been deposited, you can simply choose to invest in whatever ETF you want. And you know what, there are thousands to choose from. But have you wondered why are ETFs so popular?

In fact, what are ETFs? What should you consider whenever you’re trying to pick an ETF?

These are all questions I will try to solve and encourage you to do more research on ETFs. As well, speak to a financial advisor for any investment decisions.

Cover photo by Markus Winkler on Unsplash

Note: I am not a financial advisor. You are trading at your own risk and should consult a financial advisor for any investment decisions. Do your own due diligence when considering investing, and this information is for education/informational purposes only. The article “Purchasing ETFs In Canada: Why Are ETFs So Popular?” serves as educational content, not investing advice.

Why Are ETFs so Popular?

ETF investing feels like it’s more popular now than it ever has been.

But focusing on the question and its answer, I think you have to look at the various aspects of an ETF.

An ETF is an investment vehicle that traditionally have low management fees.

So, whenever you are holding a specific ETF, it costs you money to maintain it.

Does this situation happen when you hold a stock? No. But this isn’t a stock. An ETF promotes diversification in a portfolio, allowing people to hedge risks and negative returns. To do so comes at a cost.

Also, ETFs are passively managed, which means that ETFs aren’t necessarily actively managed by a hedge fund manager or some other professional. Yes, they are rebalanced every so often. Usually, you can find this information if you visit the issuer’s website and look for the particular security.

What an ETF does so well is it provides investors with convenience in not needing to research what stocks or other securities to directly invest in.

All investors need to do on their end is to pick a couple of ETFs and base their investment money around those ETFs. Just deposit money, place it in an ETF, and let it grow. Little hassle and lots of time saved.

Most securities managed by an issuer or by a fund manager, whomever, come so at a cost since they are actively rebalancing and changing the security to meet your needs. You can’t really have it all at no cost.

So, having a security that is low cost, can beat out traditional returns by active fund managers, and providing convenience to investors is a recipe for popularity.

What Are ETFs?

So, now that has been clarified, what is an ETF?

An ETF (known as an exchange traded fund) is a publicly traded security that comprises many other securities in its holdings. What are these other securities? Well, they could be stocks, REITs, or even bitcoin!

As well, they are exchange traded products that follows a certain index or other benchmarks and tries to replicate its returns.

Let me use an example to illustrate an ETFs definition.

First Example:

Imagine there are a total of 100 houses in a neighbourhood near you.

You walk into this neighbourhood and are looking to invest in a house for some rental income.

A real estate agent walks towards you and helps you find a deal on the house, quite a good deal.

You decide purchase the house and start renting it out to someone.

Six months pass, and there is a fire. Ten of the homes are affected vastly, so they are burned to the ground completely.

Among those, ten included your rental property. Meaning now, it’s completely gone (assume you had no insurance either).

Under this scenario, you lost your entire investment.

But let’s go back to the beginning. Whenever the real estate agent spoke to you, they offered to give you a deal to purchase 1% of each of the houses rather than a single property.

Instead of purchasing one home, you take the other deal.

The same fire happens six months after, but now you still have 1% in the remaining 90 properties. Yes, your investment has gone down, but at the same time, the other properties may have appraised to offset the losses experienced through the fire.

Second Example:

To show a very rough example, this is a chart representing the earnings from each holding in the ETF. As you can see, one of the holdings earnings were so high, it negated the first’s loss.

It was initially posted in my article on investing for beginners, which you should check out if you are a beginner to investing.

Are ETFs Mutual Funds?

No, they are not mutual funds, but they are very similar to mutual funds. Both provide diversification to various amounts of securities. Also, offer investors the ability to purchase, hold, and let their investment go to work.

If you’ve done some research into various ETFs and mutual funds, you might notice there are specific funds designed to track an index or replicate it. But a difference between the two are the fees.

Both have a fee, but you will find that traditional mutual funds typically have significantly higher management fees than those charged to ETFs. The average MER (management expense ratio) for a mutual fund is between 0.5% and 1.0%.

There are several ETFs that you can find that have a lower fee than the average above (see the ETFs that have caught my eye below).

Mutual funds are also actively managed versus ETFs being passively managed, as described before. Therefore, in a mutual fund, a manager or managers will be actively rebalancing the fund, purchasing or selling new securities, all to give you a good return, and of course, beat the returns provided from the markets.

To provide you a quick glimpse of the differences, we will look at a brief example using two different securities that track mid-cap companies (companies with a market cap between $2 billion and $10 billion).

 Mackenzie US Small-Mid Cap Growth ClassVanguard Mid-Cap Index Fund ETF Shares (VO)
Price (as of May 5, 2021):$63.16$230.12
MER:1.05%0.04%
Dividend Yield:Unsure1.31%
Yearly Return:42.1%70.72%
Return over 5 Years:17.8%14.60%
Return over 10 Years:15.5%12.29%

Are ETFs Index Funds?

Well, in a sense, they are. Index funds can either be a mutual fund or ETF that attempts to track a particular benchmark. One of the most recommended ETFs you might hear is an S&P 500 ETF. As we know, the S&P 500 is an index that tracks the largest 500 U.S.-based companies.

While we typically associate the MER as the direct cost of holding an ETF, we must consider the tracking difference.

Well, what do you mean? What I’m saying is that ETFs do not perfectly track a particular index. There can be a lost amount of earnings (or gain) as a result of the difference. Should you actively consider it in your investing strategy? Maybe not, only if you are obsessed with earning the most you can.

Regardless, various ETFs will track different indexes but note that not all are cheap. Some S&P 500 ETFs might run you a couple of hundred dollars per security, so you might be left out if you don’t have that amount of cash.

Do ETFs Pay Dividends?

ETFs can pay dividends, just like a stock, but they will not always yield a dividend.

The first distribution method of a dividend is through cash. Whenever it comes time to pay the dividend out to each of the investors, the issuer will appropriately distribute the cash into each of the investor’s accounts. Once you have received the dividend, you are free to withdraw it, reinvest it, or save it for another opportunity.

Just like stocks, there are important dates to consider when investing in dividend ETFs:

  • Declaration date: This date is when the board of directors in a public company announces and declares the dividends to be paid.
  • Ex-dividend date: This date is announced to inform new investors that the stock will not pay a dividend on the particular date (or the next day).
  • Record date: As the name implies, this date is where the board of directors will analyze their records to determine which investors are owed a dividend.
  • Payment date: The date where the dividend is paid.

The additional way dividends can be distributed is through reinvestment in the ETF. So, if the manager is instead going to take the total distributions and reinvest it in the ETFs, you will still get a portion of the reinvestment. It depends on the yield, of course.

However, you should still be able to share the portion of the reinvestment you have received for cash if you rather have cash than additional holdings in the ETF.

Why would someone want the reinvestment of dividends over cash? Of course, to increase their position in the ETF and do so with no trade fee attached.

How Are ETFs Taxed?

ETFs are taxed in several ways. The first way and probably the most obvious is through capital gains.

In the image above, you will see that capital gains are equal to the ending value of the investment minus the beginning value of the investment.

Taxable capital gains in Canada are taxed at 50% of all capital gains.

If this were a situation where instead of Serge gaining $500 from his investment, he lost $500 from his investment, it would be an allowable capital loss.

The calculations are the same; allowable capital losses are taxed at 50%, meaning Serge can offset some of his income before income tax and pay fewer taxes overall.

The additional way that you are taxed with ETFs is through dividends. Since the holdings in ETFs, especially one that tracks an index like the S&P 500, the dividends will be treated as eligible dividends.

Of course, there will be a 15% withholding tax, even if the ETFs are held in a TFSA, on dividends that derive from U.S. companies.

Even if the dividends are reinvested in the ETF by the manager, the distribution will be taxed whenever they have been received.

Also, since the reinvested contributions will increase the adjusted cost base (cost of the investment), they will result in a lower amount of taxable capital gains. However, you are taxed on the reinvested contributions already.

How ETFs are Priced:

Photo by Mika Baumeister on Unsplash

So, is an ETF’s price based on the holdings? Or is it based on the market’s value of the ETF? Well, it’s both.

I didn’t know this myself initially when learning about ETFs. I always assumed it was one or the other. Of course, the ETF is based on its holdings, so when all the assets increase or decrease in value, the fund will be vastly affected.

However, at the same time, this is a security as well, so psychological behaviour is the other factor that bases its price.

Therefore, we will buy upon the change of the market trends rather than the net asset value of the holdings. However, in some cases, there may be funds that track the NAV instead, which you will want to do some research about each fund.

Yet, the market price and NAV try to be as close as possible to one another, but of course, the marketplace can affect that.

Who Creates ETFs?

Usually, there is an investment management company that will offer ETFs to the public. These investment management companies include Vanguard, Blackrock, State Street, and Fidelity.

How Often do ETFs Change their Holdings?

This type of information can be provided on the manager’s website. However, to keep it brief, some ETFs will change their holdings quarterly, while others may do it more or less frequently.

Can ETFs Split?

Photo by Ussama Azam on Unsplash

I didn’t know this initially either, but as stocks can, ETFs can split.

So, what does it mean to split an ETF?

A stock split or ETF split occurs whenever management decides to increase the number of shares they offer and therefore give you an increase in shares. Usually, they could be a 2-for-1 split (where you receive two stocks for everyone you own).

That sounds great, but in all reality, it isn’t necessarily so.

Let me use an example.

MyETF currently has 3,000,000 funds outstanding.

Today, they announce that they are going to offer a 2-for-1 stock split.

Leading up to the stock split, the fund had a total market cap of $6,000,000.

Therefore, before the split, their price per fund was $2 ($6,000,000/3,000,000).

Since the stock split aims to provide an extra 3,000,000 funds (2 x 3,000,000), the market cap does not change.

After the immediate stock split, the price is $1 per fund ($6,000,000/6,000,000).

However, the total amount that you have invested doesn’t necessarily change. You have just received an extra stock, and the total value remains the same, just as does the cost.

They could offer a stock/ETF split if they do not have enough cash to provide a distribution itself, or they could do so to provide more shares/funds to the public to purchase.

What are the Pros and Cons of ETFs?

I may have been asked once “What are some benefits of trading ETFs?” Regardless, these are some of the advantages there are to these investment vehicles.

Pros: 
DiversificationMany ETFs hold several stocks or securities from publicly listed companies, making it cheaper to own portions of securities in these companies
Low FeesThey offer significantly lower fees than most mutual funds
DirectedInstead of being an active investor, rely on an index or manager to provide you high risk-high reward returns or conservative earnings
ConvenienceSaves you time instead of having to research what securities to purchase for your portfolio
Great Passive IncomeSeveral ETFs are catered to provide significant dividends, which allows you to use the power of compounding to your advantage or simply hold extra cash

The benefits significantly highlight advantages to those who want to invest passively or anyone with some extra contribution room and want to add a diversified position. But if asked, “What are the downsides of investing in ETFs?” these investment funds have their consequences of course:

Cons: 
No Control over HoldingsManagers or companies can increase or decrease their holdings, as well as what companies are added to holdings at their own will
Can be ExpensiveSome ETFs can be as expensive as a stock is, making it vastly unaffordable or leaving little contribution room left
Does Not Always Track Benchmark PerfectlyAs a result of not tracking the benchmark closely or consistently, you could be missing out on significant earnings, mainly if other funds can consistently follow the benchmark.

Will ETFs recover?

I’m assuming this question is based on whether ETFs will increase in price after it has suffered a significant downfall.

Yes, ETFs can recover. However, they can also drop to the point where you either lose your entire investment or are down a significant portion of money.

Maybe instead, this question is based on the stock market crash that occurred roughly a year ago, in which case they have recovered.

But it is essential to do your research on an ETF, just as you would a stock. Carefully consider what it represents and its key characteristics at the very least to determine its strength.

How to Analyze ETFs:

Photo by Jon Tyson on Unsplash

I will discuss the way that I currently analyze ETFs.

Firstly, I look at the objective and/or the product summary. This way, I can understand the ETF better and what I can expect from management going forward. For example, if I view an S&P 500 ETF, I know management will add new companies that enter the top 500.

This leads me to my next point. I view the holdings of the ETF itself. Now am I going to completely view the entire holdings that are in a Russell 2000 ETF? No, of course not. I don’t want to view the thousands of holdings it has.

Instead, I will view the top 10, maybe the top 20, or furthermore. As well, I’ll look at the exposure to each sector the fund possesses. 

Next, I will view the management fee associated with the fund.

Is there a particular range I look for? I would say anything under 0.5% would be too much for my satisfaction.

But I might attempt to search for a great ETF that pays a dividend at least above the management fee. That way, the MER can be offset with the dividend, and I don’t have to worry about the MER. Instead, I can focus on the other features of the ETF and if it fits the needs of my investment strategy.

The past performance is also another factor to consider, at least for myself. I’ve said it before and will repeat it.

Past performances do not indicate future returns.

Instead, it serves as a framework and indication of how well the ETF has done previously and what could be expected for its future performance.

I will not solely purchase an ETF because of the past performance, especially if it has a very volatile return over the past couple of years.

There’s also importance to view how closely the fund tracks the benchmark because it may not be perfect in following the benchmark, and as a result, you are losing out on potential earnings. If it’s close, then that is fantastic, because it’s not going to be perfect always. If consistent, I know that it can be trusted to earn relative returns compared to the benchmark over a more extended period. 

Yes, maybe these strategies are basic. However, it does and should not be complicated when investing in ETFs, especially for holding the funds for the long term. It’s important to purchase something consistently, and of course, based on your risk tolerance.

5 ETFs that Have Caught my Eye:

I’ll display five of the ETFs I have been keeping my eye on as per request by the Smart Money podcast. They requested this on Instagram, so if you haven’t had a chance to @bank_breaking on Instagram, please consider doing so.

Of course, do your own research if you decide to look into these ETFs and consult a financial advisor for any financial decisions.

1. Vanguard S&P 500 ETF (VOO)

I’m sure if you’ve done any research online about popular ETFs or recommended ones, this one has appeared, and likely numerous times. This is popular because of its track record. Just look at its performance over the past 100 years; it’s had average annual returns of 10%. 

There are a couple of different ETFs that are based upon the S&P 500 index. Of course, each has its differences, but I went with Vanguard because of the price based upon its other competitors.

Its expense ratio is 0.03%, signifying how cheap it is to hold compared to other ETFs in general.

Vanguard is one of the largest investment management companies in the world, and are best known for their mutual funds and ETFs. They are reputable to my eye and have closely attempted to track returns to the S&P 500 index.

For the past ten years, the fund has provided an annual return of 14.14%, which is much better than you ever will find in a savings account. Plus, it’s tough sometimes to out beat the market, so why not join in and enjoy some of the returns replicated by this ETF.

2. Vanguard Health Care Index Fund ETF Shares (VHT)

2020 has been the year for health care, for obvious reasons. The amount of work that front-line workers have endured is unimaginable, and our hats must go off to them.

I do think that the health care sector globally is only going to grow. There’s always going to be a demand for it, at least in the considerable future, until we can self-regenerate fully or something. Especially after developing this COVID-19 vaccine, there will be future diseases that will need new vaccines.

So, while we continue the need to depend on expanding and continuously developing health care, I will not go against it and am a firm believer of the future of this ETF.

Looking at some of its metrics, it is considered quite risky, so you might not necessarily want to invest in this if you don’t like risk. It also carries an expense ratio of 0.10% and holds around 449 stocks.

Biotechnology, health care equipment, and pharmaceuticals are among the most significant sectors represented in its holdings, signifying its diversification across multiple sectors.

Its benchmark is the Spliced US IMI Health Care 25/50, and it also has done a relatively good job at tracking it. Since its inception, it has produced nearly 11% of annual returns, making it an enticing ETF to consider.

3. Vanguard Information Technology Index Fund ETF Shares (VGT)

Another one of my favourite sector-based ETFs at the moment is the Vanguard Information Technology Index Fund ETF Shares (VGT). We all know how much technology affects our lives, and the number of new technology-based companies seems to increase.

I expect that the technology sector will only get stronger in the future, especially for companies like Microsoft and Apple, increasing the quality of their products, releasing new products, and attempting new projects. Another sector that I will not bet against for the foreseeable future

Despite my projections, this ETF also has the same MER as the one based on the health care sector and pays a small yield of 0.72%. Although the yield may not be convincing, it would not be the sole focus for holding this ETF. To me, it would be about the potential for gains.

Among its top sector holdings are semiconductors, systems software, and technology hardware, and storage. It holds 333 stocks which mean diversification is not a problem, with companies including Apple, Microsoft, and Visa among its ten most extensive holdings.

Lastly, over the past ten years, this ETF has averaged an annual return of 20.41%! Now that is impressive to me, and even if it only brings 10% for the next ten years, it would make for a great addition, only if you believe in the technology sector for the future.

4. iShares S&P/TSX Composite High Dividend Index ETF (XEI.TO)

Would I consider this the best Canadian dividend ETF? I’m not sure, but I think it would be one of the best. I initially discussed this in my article on Canadian dividend ETFs that can be purchased for $20.

Since then, it has increased in price and today is sitting on a yearly return of 20%. But since its inception, it has seen annual returns of 6.20%, not as impressive as the other ETFs listed here, but still significant, given that this is an ETF based on dividends. However, its benchmark saw 6.54% returns over that same time, signifying that the ETF does not closely follow it as much as it could.

Speaking on the dividend, its yield as of May 8, 2021, is 4.41% according to Yahoo Finance and pays a total amount of roughly $1.027 per year and distributes that amount throughout each month of the year. Now that, of course, might not seem very enticing, especially given that you can find stocks that pay a higher dividend, but the more funds you purchase, the greater the dividend will be, and that’s why I like the fund very much.

The total number of holdings under this ETF is 74, and it is well diversified across several sectors. These sectors include energy, financials, communication, and utilities. Its diversification was why it had initially caught my attention compared to some of the other divided ETFs I have viewed. Others might be heavily invested in specific sectors where if the industry took an enormous hit, the ETF would feel its effects. Not to say XEI.TO wouldn’t be similar in that nature.

Its most significant holdings include Enbridge, TC Energy Corp, and TD. Of course, a dividend investing strategy that one can always use is to look at an ETF based on paying high dividends, such as this one, and investing in the companies it holds.

Lastly, the MER is 0.22%, marking the highest expense ratio amongst these 5 ETFs, yet still, a good MER that I will pay to hold this fund.

5. Vanguard Russell 2000 Index Fund ETF Shares (VTWO)

The Russell 2000 Index tracks small-cap U.S. stocks, so basing an ETF on this index means that it brings many risks but brings with it some reward as well.

One thing that can be said about the Vanguard ETF is it does not lack diversification in the least. It has 2097 stocks being held in the fund, which is, well, it’s a lot. I don’t know any other way to describe it. Its largest holdings include Caesars Entertainment, Novavax, and GameStonk, I mean GameStop.

The Russell 2000 ETF is one of the cheaper ones featured and carries an expense ratio of 0.10%, like the other Vanguard-based ETFs. But, be prepared for significant swings at times, as it has and will have some volatility attached to the fund.

Despite any volatility, it has seen tremendous returns over its inception, at 13.71% being returned to investors annually. The fund paid quarterly dividends last year that equated to a total amount of roughly $1.46.

Conclusion:

Even though ETFs can be a great investment for yourself, it is important to remember portfolio management and that you still will need to do some work if you want to hold multiple traded funds. The same can be said about financial planning, you need to carefully construct a plan to budget, save, and invest, including choosing your investments, which may be ETFs.

But let’s be honest, if we could find an investment on an underlying index that guaranteed returns as high as some interest rates on credit cards, a lot of us would scramble to invest in that security.

Did I miss anything in this article? Please let me know down below in the comments.

As well, what is an ETF that you are keeping track of at this moment? Provide your answers below as well.

I mentioned plenty of U.S. based ETFs, but don’t let that shy you away from the ETFs that are Canadian based.

Thank you for reading this article and as always, check out the other articles on the website by using the menu above.

Yahoo Finance was used to collect the ETF’s graphs and no changes were made to each image.

Note: I am not a financial advisor. You are trading at your own risk and should consult a financial advisor for any investment decisions. Do your own due diligence when considering investing, and this information is for education/informational purposes only. The article “Purchasing ETFs In Canada: Why Are ETFs So Popular?” serves as educational content, not investing advice.  

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