What is an ETF?
An Exchange-Traded Fund (ETF) is essentially a cross between a mutual fund and a security. It combines some of the investment features of a mutual fund with the trading qualities of a stock. As with mutual funds, ETFs can own a variety of securities such as stocks, bonds and commodities. But like stocks, they are bought and sold on stock exchanges throughout the day.
Benefits of ETFs
ETFs are often praised for democratizing the investment experience by providing advantages that were once available primarily to large institutional investors. Today, many investors can enhance their portfolios with ETFs and benefit from the following advantages:
- Lower costs: Compared to mutual funds, ETF management fees and operating costs are generally lower. Lower fees mean more of your savings is invested which can improve your investment returns.
However, as ETFs are traded on an exchange, there may be brokerage commissions charged each time you buy/sell.
- Trading Flexibility: Because ETFs trade on a stock exchange, you can buy and sell them whenever the stock market is open. Also, as ETF prices change throughout the day, you can take advantage of these movements.
- Transparency: ETF providers publish the list of securities they hold so you know exactly what you're investing in (active ETFs must publicly disclose holdings daily). Knowing what you're invested in is important because it allows you to see if your investments are adequately diversified. Or, if you're invested in an Index ETF, how closely it tracks the benchmark it's designed to follow.
- Diversification: Like most mutual funds, ETFs can offer you access to virtually every corner of the market. In a single ETF, you could own securities from different sectors, countries or industries. While some ETFs are designed to provide diversification, which can help you reduce concentration risk, there are other ETFs that are designed to invest in specific markets or strategies. These types of ETFs are not broadly diversified, but combined with other investments, they can help you diversify into different markets and enhance returns.
Passively versus Actively managed ETFs
- Traditionally, ETFs were designed to be passive investments that track a specific index. For example, the TD U.S. Equity Index ETF is designed and managed to replicate the performance of the broad U.S. equity market index.
- With actively-managed ETFs, the portfolio managers pick securities based on their research and strategies. They do not adhere to owning the same securities as an index. For example, the TD Active Preferred Share ETF is actively managed as the portfolio manager seeks to own shares they believe will add a high level of income for investors.
Difference between ETFs vs Mutual Funds
While ETFs have some of the same investment features of mutual funds such as diversification, there are some fundamental differences.
Comparison of ETFs, Mutual Funds and Stocks
|Underlying investments||Securities, fixed income, commodities, currency, derivatives.||Securities, fixed income, commodities, currency, derivatives.||None|
|Pricing||Based on bid and ask price. Bid is the highest price investors will pay. Ask is the lowest price investors will sell the ETF. Price changes throughout the day.||Price is calculated at end of day. It is based on the market value of investments in the fund divided by number of units outstanding. (i.e. NAVPS).||Based on bid and ask price. Bid is the highest price investors will pay. Ask is the lowest price investors will sell the stock. Price change throughout the day.|
|Eligible for pre-authorized contribution plan||No||Yes. Investors can use automatic plan that transfers money from bank account to investments.||No|
|Management fees||Typically, lower than 1%||Often between 1% to 3%||None|
|Transaction costs/fees||Brokerage commission charged on buying and selling ETFs.||Several purchase options, some do not incur commissions. No commissions charged on selling mutual funds.||Brokerage commission charged on buying and selling ETFs.|
|Rebalancing costs||Brokerage commissions (but less expensive than stocks/bonds).||Typically no costs to switch between funds.||Brokerage commission on additional stock purchased or sold.|
|Distributions||Distributions and interest can be reinvested.||Distributions and interest can be reinvested.||Distributions must be manually reinvested.|
How ETFs are Taxed
ETFs may be considered tax efficient because they experience few taxable events. Passive ETFs, in particular, will experience a lower turnover of the underlying investments.
Additionally, ETFs are traded on a stock exchange. As a result, securities held in the ETF need not be sold when aholder investor disposes of their ETF units – unlike when units of a mutual fund are redeemed. This results in relatively low trading expenses and potentially low taxable distributions. The seller will be responsible for any capital gains/losses they may realize when the ETF is sold.
Investing in ETFs
One question often asked is "What are the best ETFs for a Tax-Free Savings Account (TFSA)?" Like an RSP, you can own any type of ETF in a TFSA. The ETFs suitable for your TFSA would depend on your goals and risk tolerance. We encourage you to work with an investment professional to determine the ETFs that are most appropriate for you.
How to Buy ETFs
You can purchase an ETF through a discount brokerage or speak to an advisor to learn which ETFs may best align with your investment objectives.
Are you an Advisor? Sign into our Advisor Dashboard for our ETF Best Practices and Strategies.
The information contained herein has been provided by TD Asset Management Inc. (“TDAM”) and is for information purposes only. The information has been drawn from sources believed to be reliable. Where such statements are based in whole or in part on information provided by third parties, they are not guaranteed to be accurate or complete. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. TDAM, The Toronto-Dominion Bank and its affiliates and related entities are not liable for any errors or omissions in the information or for any loss or damage suffered.
Commissions, management fees and expenses all may be associated with mutual fund and/or exchange traded fund ("ETF") investments (collectively, "the Funds"). Trailing commissions may be associated with mutual fund investments. ETF units are bought and sold at market price on a stock exchange and brokerage commissions will reduce returns. Please read the fund facts or summary documents and the prospectus, which contain detailed investment information, before investing in the Funds. The Funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer and are not guaranteed or insured. Their values change frequently. There can be no assurances that a money market fund will be able to maintain its net asset value per unit at a constant amount or that the full amount of your investment will be returned to you. Past performance may not be repeated.
The TD Canadian Aggregate Bond Index ETF, TD Canadian Equity Index ETF, TD U.S. Equity Index ETF, TD U.S. Equity CAD Hedged Index ETF, TD International Equity Index ETF, TD International Equity CAD Hedged Index ETF and TD Global Technology Leaders ETF (the “TD ETFs”) are not sponsored, promoted, sold or supported in any other manner by Solactive AG nor does Solactive AG offer any express or implicit guarantee or assurance either with regard to the results of using the Index (as defined below) and/or any trade mark(s) associated with the Index or the price of the Index at any time or in any other respect. The Solactive Canadian Select Universe Bond Index, Solactive Canada Broad Market Index (CA NTR), Solactive US Large Cap CAD Index (CA NTR), Solactive US Large Cap Hedged to CAD Index (CA NTR), Solactive GBS Developed Markets ex North America Large & Mid Cap CAD Index (CA NTR), Solactive GBS Developed Markets ex North America Large & Mid Cap Hedged to CAD Index (CA NTR) and Solactive Global Technology Leaders Index (CA NTR) are calculated and published by Solactive AG. Solactive AG uses its best efforts to ensure that the Index is calculated correctly. Irrespective of its obligations towards the Issuer, Solactive AG has no obligation to point out errors in the Index to third parties including but not limited to investors and/or financial intermediaries of the TD ETFs. Neither publication of the Index by Solactive AG nor the licensing of the Index or any trade mark(s) associated with the Index for the purpose of use in connection with the TD ETFs constitutes a recommendation by Solactive AG to invest capital in said TD ETFs nor does it in any way represent an assurance or opinion of Solactive AG with regard to any investment in this TD ETFs.
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