With that said, independent investor or not, the world of investments always comes with some risks. Exchange traded funds (ETFs) can turn out to be a good avenue for ensuring diversification of your portfolio. Here are some advantages to take from ETFs when you’re holding the reins of your own investments.
The perfect hybrid between stocks and index funds
ETFs are traded on the stock market like a stock. Except instead of throwing all your allocations into one business, you benefit from a basket of securities from which you can diversify your portfolio.
Like market securities, they are highly liquid: you can sell them when you want without penalties associated with withdrawals imposed by investment funds or guaranteed investment certificates.
You’ll also pay lower management fees than those of other funds, since their managers are inclined to invest in the same securities as the benchmark indexes, like the S&P 500.
Also, taxes can put a large dent in the return of certain investment funds, whereas when we invest in ETFs, it is possible to improve your fiscal efficiency thanks to diversification.
It’s also possible to reduce the volatility normally associated with stocks by investing in ETFs that are concentrated in more “conservative” sectors, such as public services or health care.
What are the advantages for an independent investor?
For those who manage their investments themselves, this diversification of ETFs bears even more importance. Investing in a company’s stocks, like Microsoft, requires an enormous amount of knowledge and time.
Reading annual reports, observations, sector trends… All this to succeed in making an informed decision and at best managing to obtain the same return as the market.
Those people at the top of finances like Warren Buffet and, on a national scale, Dan Bortolotti of the CouchPotato blog, are constantly repeating: if your full-time job isn’t selecting companies to invest in, don’t waste your time trying. Even professionals rarely succeed in hitting a home run and beating the market.
ETFs allow for a more passive management where you can manage the distribution of your stocks in funds that offer a good return, and at a better cost.
Factors to consider
Here are the main factors to assess before investing in an exchange traded fund:
- Benchmark index: Two ETFs that evolve in the same sector can copy different indexes and therefore present different risks and returns. Ensure that the index corresponds to your expectations. Also, certain indexes contain equities that are seldom traded, which makes reproducing their composition more difficult.
- Fiscal efficiency: Certainly, exchange traded funds are more interesting from a tax point of view than mutual investment funds. ETFs do not, however, avoid taxes, especially when they include international securities or when there’s a risk of paying double revenue on the dividends.
- Purchase and sales commissions: If you’re making frequent transactions, the brokerage costs can quickly snowball and undermine your investments, whereas by investing a large amount without touching it over a long period, these fees won’t have as large of an impact.
- Diversity: The more an ETF is diversified, the better it reflects the performance of the intended stock category.
- Liquidity: If you don’t want to lose anything when purchasing and selling, it’s better to focus on funds that enjoy high liquidity.
The best ETFs
In Canada, more than 150 exchange traded funds are centred around revenue production for investors in search of the best returns. Here is a list:
- FNB Vanguard High Dividend Yield (VYM)
- iShares S&P/TSX Composite High Dividend ETF (XEI/TSX)
- BMO Canadian Dividend ETF (ZDV/TSX)
- BMO Mid-Term U.S. IG Corporate
- iShares DEX HYBrid Bond Index XHB
- PowerShares Senior Loan (CAD Hedged) Index ETF BKL
- iShares U.S. High Yield Bond Index Fund (CAD-Hedged) XHY
- PowerShares Fundam High Yield Corp Bond (CAD Hedged) Index ETF PFH
Regardless of the investment vehicle that we choose when looking to manage our own portfolio, we should always remember two fundamental objectives: aim to reduce costs and maximize the diversification of the portfolio.
To find out more, subscribe to the National Bank newsletter.
