What is an Exchange Traded Fund?

For the average investor, the investment revolution began with the mutual fund. A mutual fund allows the average Joe or Jane to buy into the stock and bond markets and create simple portfolios. On ‘what is an investment portfolio?’ have a read of my blog post This Is Easy Street For Canadian Investors. You are essentially owning a big basket of companies for growth, while the bonds help to reduce the risk of the investment portfolio.

Before mutual funds investment portfolios were the domain of the rich and famous. Investors had to buy the stocks and bonds directly on stock exchanges, and usually with the help of a broker. Mutual funds spelled liberation, they opened the door to the investment world for those with very modest sums available to invest. But of course there is a cost to investing and creating mutual funds, and those costs can be very high, especially in Canada. Those fees will eat into your returns, as the fees are paid for by the returns of the portfolio. A mutual fund might have to use your 2.5% in cash dividends the fund is collecting to pay the 2.5% fee owed to the mutual fund management company and the advisor that sells you that fund. Bye-bye dividends. In the end, the mutual fund creators and advisors are collecting those dividends – not you. A significant portion of the investment returns are going in someone else’s pocket. Over a lifetime of investing, a typical investor could pay fees that total hundreds of thousands of dollars.

So how do you keep almost all of the investment returns in your pocket? Enter the Exchange Traded Fund or ETF for short. Yes, they built a better mousetrap.

An ETF is like a mutual fund in that it holds a big basket of stocks or companies, but you buy that fund on a stock exchange – hence the ‘exchange traded’ part of the ETF. It’s a fund that you buy like a stock. And yes, there will be a fee for that purchase, typically in the range of $5-10 per purchase or sell. That said the ongoing fees can be as low as .03%. That’s right, that’s 3/100th of 1 percent. The average Management Expense Ratio (MER) in Canada for mutual funds is above 2.2%. You can imagine what happens when you keep an additional 2% or more in your pocket each year.

Here’s an example from Vanguard, the ETF pioneer. The example is based on a baseline of zero fees, and then fees applied at 2% annual, based on an initial $100,000 investment earning 6% annual for 25 years.

The cost of fees - Vanguard
The high fee effect

Incredibly, what we witness is the fees outpacing the returns, that negative compounding is nasty stuff. The baseline scenario has an ending portfolio value of $430,000 while the portfolio paying the 2% fee has a value of $260,000. Of course, you don’t have to give away your hard earned monies.

As an example here’s an ETF that allows you to buy a big basket of leading US companies for .07% in annual fees. The stock fund ticker is XUU and the ETF is offered by iShares Canada. With the press of that XUU stock ticker you would own over 3,400 US companies. At the top of the list you’d become a business owner of Apple, Google, Microsoft, Facebook, Amazon, Johnson & Johnson, Visa, Home Depot, Lowe’s, Walmart, McDonald’s and Costco and on and on.

In Canada, you can enter 3 letters and purchase the Canadian market index for .06%. For more on the investment style that allows for those lower fees please have a read of What is Index Investing?

It’s that simple. You enter a stock ticker and you immediately own a very large basket of market leading companies at 90-98% less than a typical mutual fund. It’s simply a superior way to invest. Based on my observations from my years an advisor who conducted hundreds of personal portfolio analysis reports, there is the potential and likelihood to earn double to triple the returns over an investment lifetime in low fee investments compared to high fee investments. That’s more than life changing. That’s the difference between spending retirement at the local trailer park (nothing wrong with that) compared to owning a beach house on Prince Edward Island.

I had to sneak in a photo from my recent PEI workcation.

Sunset
Sunset at Brackley Beach, PEI

It’s not that difficult to set up and maintain your own ETF portfolio. You can see my model portfolio ideas on this page. I am more than happy to help you navigate your way through that process. There is no catch, no cost. These days I get paid in Karma.

If you are not comfortable (yet) with the idea of managing your own ETF portfolio, there are many simple Managed Portfolio Solutions that includes the Robo Advisors. Those robo advisors also employ those low cost ETFs to create complete balanced portfolios. Those portfolios are managed for you at a very reasonable cost. On that page, you’ll also see a couple of mutual fund companies that offer funds with very reasonable fees. There are many simple low cost options available to Canadians.

There are many ways to stop giving your money away.

shutterstockMoneyMagnets

 

Thanks for reading. Please help your fellow Canadians by sharing this blog. I am more than happy to answer any questions.

Dale @ cuthecrapinvesting@gmail.com

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