ETF’s in TFSA’s
An exchange traded fund (ETF) is much like a traditional stock in that they both trade throughout the day. However, unlike stocks which are based on a specific company, ETFs are based on a pool of companies, much like mutual funds. In essence, you can think of ETFs as a “hybrid” between mutual funds and stocks, incorporating the benefits of both.
|Track a pool of companies||Track individual companies||Track a pool of companies|
|Trade at the end of the day||Trade anytime during the day||Trade anytime during the day|
|Actively traded||Actively traded||Linked to an index: passively-traded|
|High MER||No MER||Low MER|
|Available at banks and credit unions||Available at brokerage firms||Available at brokerage firms|
ETFs are popular with investors
ETFs are popular among traders because you can hedge your risks by diversifying amongst many companies. When investing in individual stocks you run the risk of losing a lot of your money if that company goes under, especially if you are a common shareholder!
With ETFs, there is still the chance your entire portfolio could be devalued if several stocks within do poorly, but this is mitigated by the presence of other stocks. As the value of a poor-value stock drops, it will gradually represent a smaller portion of your ETF, and over time it will gradually be replaced by a higher-value stock.
Another reason ETFs are so popular is that they are easy to liquidate, unlike other assets such as real estate or a business. ETF transactions are settled within 3 days, which means your money is relatively accessible in the event of an emergency.
Types of ETFs
When deciding what ETFs to add to your TFSA portfolio, most people choose one of the following strategies:
- Trade index-based ETFs: These are based on a particular index such as NASDAQ or S&P500 and represent an otherwise unrelated group of industries.
- Trade specialist ETFs: These focus on a particular industry such as natural resources, technology, or precious metals. Some ETFs can focus even more narrowly on a sector such as oil, nanotechnology, or gold.
What ETFs to put in your TFSA?
- To have the best diversity, choose a combination of index-based ETFs and specialist ETFs. This way you can hold securities in all sectors of the economy.
- Add the ETFs slowly to your portfolio…this reduces volatility and the vulnerability of your TFSA.
- ETFs with foreign companies may not be as good for your personal financial situation as Canadian ETFs: foreign dividends are taxed at 15% and Canadian ones are not.
Unlike mutual funds which have a portfolio manager buying and selling investments on your behalf, ETFs are linked to an index. ETF management expense ratios (MERs) are correspondingly lower than mutual funds’ MERs.
Because ETFs are bought through a brokerage firm, there is a degree of self-investing required on your part. Ask if the firm charges commission or transfer fees. These fees vary and can eat into your potential profits especially if you are prone to making lots of small transactions.