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. You are essentially owning a big basket of companies for growth, while the bonds help to reduce the risk of the investment portfolio. The problem with mutual funds is that the mutual fund managers who pick the stocks and bonds charge very high fees. Those fees eat into your returns. With an exchange traded fund we can essentially own the same companies and cut our fees by 90% or more. The fee savings could double your returns over time. This post will help you discover – what is an exchange traded fund?

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. Unfortunately, Canadians pay some of the highest fees in the world. Those fees are wealth destroyers.

Along came Exchange Traded Funds to change the game once again.

Wealth destroying fees

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 value is going in someone else’s pocket. Over a lifetime of investing, a typical investor could pay fees that total hundreds of thousands of dollars.

They’ve built a better investment mousetrap

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’ve 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.

If you sign up at a brokerage such as Questrade you can buy ETFs for free. There is no transaction cost.

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 about 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.

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 money.

Of course the big Canadian banks are the biggest ‘sellers’ of mutual funds. Reformed banker Larry Bates spills the beans on the big bank mutual funds and suggests in his best-selling book …

Don’t give away half of your investment returns. Beat the bank.

In that post you’ll find a link to a tool that allows you to discover the cost of your high fee mutual funds.

Buy the U.S. stock market for 0.07%

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. By entering the XUU stock ticker and pressing that buy button you would own over 3,400 US companies.

For more on the investment style that allows for those lower fees please have a read of What is Index Investing? As a teaser analogy, you wouldn’t bet that the Toronto Maple Leafs or Montreal Canadians are going to win the Stanley Cup next year. You’re going to own the entire NHL and every team. Index investing is the same, a mutual fund picks a few stocks, an index-based ETF buys the entire stock market.

At the top of the list for US stocks you’d become an owner of Apple, Google, Microsoft, Facebook, Amazon, Johnson & Johnson, Visa, Home Depot, Lowe’s, Walmart, McDonald’s, Costco and on and on and on. You share in their profits and business success.

Buy the Canadian stock market for .06%

In Canada, you can enter 3 letters and purchase the Canadian stock market (ticker XIC) for .06%.

Own international stocks for 0.22%

You can own the combined European, Japanese and other interationa stock markets for 0.22%. The ticker symbol is XEF.

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 one of my PEI workcations.

It’s not that difficult to set up and maintain your own ETF portfolio.

Single (all-in-one) fund solutions

If you are not comfortable with the idea of managing your own ETF portfolio, there are many simple Managed Portfolio Solutions. They are called asset allocation ETFs.

By way of one ETF/Fund you can hold a very well diversifed global portfolio with total annual fees in the 0.17% to 0.28% range.

If you want advice, financial planning and low-fee ETF portfolios check out Justwealth, Canada’s top Robo Advisor.

There are many ways to stop giving your money away.

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