Investing in ETF’s

Many of our readers ask us how to invest in ETF’s (exchange traded funds). I hesitate to give a quick answer to that before asking “Should you invest in ETF’s?”. If you have been following the Scrooge Guide for a while you will know we often praise ETF’s as a good solid investment. The reason is simple: they are a pool of assets that follow a market and charge very low administrative fees to do so. In some ways they are like mutual funds because not all your eggs are in one basket. But unlike mutual funds they have very low MER’s (management expense ratio – the yearly administrative fees), typically 75% to 95% less than mutual funds, and they are traded like equities. They are also available in sectors for those who like to do sector investing.You should probably invest in ETF’s if you would normally invest in equities or equity based mutual funds. In other words, if you are tolerant to the risk inherent in equities then you will be tolerant to the swings in ETF’s. An ETF follows the market, when the market goes up the ETF goes up, when the market goes down the ETF value goes down. That’s the way it is supposed to behave, and should behave. The theory is, over the long run, the market will go up and with it the ETF will go up. An ETF (just like a mutual fund) is usually less risky to hold than a single stock or even 10 stocks, because they are more diversified.To plan your investments, you should break down the total that you want to invest into the classes of assets that you want to invest in (eg. fixed income, equities, etc.). A common rule of thumb is the fixed income (low risk) portion of your portfolio in percentage should approximate your age. So if you are 35 years old then 35% of your portfolio should be fixed income and 65% (which is the remainder) in equities. Now lets look at the Equities part of the portfolio. How much of that should be ETF’s and what types of ETF’s? The short answer is “that depends”. It depends again how risk tolerant you are. An ETF that follows the Columbian stock market may be (I’m just guessing) more risky than one that follows the S&P 500 in the USA, or the TSX in Canada. If you are highly risk tolerant then you might want 60% Domestic, and 40% Foreign ETF’s. If you have a lower risk tolerance then perhaps 50% domestic ETF’s and 50% in a solidly performing dividend mutual fund with a low standard deviation history would be a good choice. If you have no risk tolerance, stay away from ETF’s and invest in good, solid, highly rated strip bonds. If all this sounds like Greek, than you better do some reading before investing, or consult a financial advisor.A good source of information on ETF’s is iunits.com in Canada and ishares.com in USA. Both of these sites have loads of information on ETF’s and have very useful calculators.Now that you have all this information on hand, you are ready to invest in some ETF’s. Since they are traded like equities you will need to buy them through a stockbroker or a discount brokerage house. Some banks offer a discount brokerage service and will set up an account for you that you can access online to trade at your convenience. Are there better investments than ETF’s? Many experts don’t think so. The reason is the low MER (which can eat up ½ of your potential growth in typical mutual funds), and the fact it tracks the market. As long as we believe the market will continue to grow over time and that most mutual funds perform below the market after MER’s are taken into account, then ETF’s will continue to be a better choice.
Scrooge