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Advisor ETF Insights

5 tips when investing in ETFs

They’re low-cost, they’re tax-efficient and they’re picking up speed with Canadian investors. Here are the best ways to incorporate exchange-traded funds into a portfolio

By: PAUL BRENT

Date: May 2, 2017

Exchange-traded funds (ETFs) are not exactly a new financial product for Canadian investors, but it could be argued that they are under-utilized, despite offering unique advantages.

This low-cost, tax-efficient investment vehicle has been available for decades, but because the mutual fund industry is so robust in Canada, it’s only in the last five or so years that ETFs have begun to pick up speed with individual investors and their financial advisors. But what’s the best way to get on board?

Here are five tips to maximize the benefits when it comes to ETFs:

1. Diversify

One of the main knocks against active management is that when compared with many ETFs, investors can be paying a higher management fee even though a number of of those managers, year to year, fail to beat the market.

“If you are invested in a highly diversified fund, sometimes it can be quite difficult for an active manager to outperform,” says Krista Matheson, head of ETFs and structured products for Manulife Investments. “So ETFs can be a very efficient way to get this exposure.”

With the single purchase of an ETF, investors can access entire markets, which makes diversification easily accessible and cost-effective. It’s a way to help protect against volatility and mitigate risk, concepts that are likely to appeal to investors of all stripes.

When deciding on which ETFs to invest in, diversification should be a top priority, considering crucial factors like sector, region and asset class.

2. Embrace the passive

In most instances, being active rather than passive might seem preferable. When it comes to investing, however, passive can trump active, argues Yves Rebetez, managing director and editor of ETF education and analysis website ETF Insight.

“People assume that when you take control of things that you are going to have better outcomes,” says Mr. Rebetez. “The problem in the world of investing is that often times, the more control that you take, the more you are at risk of screwing up.”

While there has been a trend towards actively-managed ETFs in recent years (which can have higher fees), ETFs that passively follow an index can be a solid choice for many investors.

3. Don’t overdo it

Just like with mutual funds, investors can hold too many ETFs in their portfolio, says Ms. Matheson.

“It can be a challenge with any investment strategy,” she explains. “If an investor owns five different Canadian equity funds, it can create overlapping exposure in sectors that they probably didn’t intend to have.”

There is no “ideal” number of ETFs or mutual funds to own, but it is possible to buy a world of equity and fixed income with just two or three ETFs if investors (and their advisors) choose wisely.

In Ms. Matheson’s case, she employs a “less is more” strategy, and typically holds just a handful of funds in her portfolio. “Keeping it simple does mitigate a lot of the work you have to do in rebalancing your portfolio,” she says.

4. Choose ETFs instead of individual stocks

Some investors crave the potentially high returns of investing in stocks. But Mr. Rebetez notes that buying and selling individual stocks (at a profit) generates capital gains and ultimately, a tax bill.

“Every time you get dinged, it reduces your net profit,” he says.

Even though ETFs trade like stocks and can be easily sold, investors tend to buy them and hold them, says Mr. Rebetez. Lower turnover means investors are able to grow their money with less capital gains.

“You wind up with a long-term, buy and hold [strategy] and the ability to compound [any wealth accumulation], without taxes playing as big a role as they would with individual stocks,” he says.

5. Bring ETFs to the table

Compared with U.S. investors, Canadians have been slow to move to ETFs, despite their significant cost advantage. However, continued education around ETFs is likely to bring more Canadian investors to their financial advisors with questions about this underutilized tool. While every investor’s situation is different, advisors should be making ETFs a discussion topic during investment meetings with clients.

“Advisors should understand that it is their responsibility and duty to look to clients’ best interests,” says Mr. Rebetez.

Sponsored by Manulife

Commentary is for general information purposes only and should not be relied on for specific financial or other advice. Opinions expressed are subject to change based on market and other conditions. Commissions, management fees and expenses all may be associated with exchange traded funds (ETFs). Investment objectives, risks, fees, expenses and other important information are contained in the prospectus, please read it before investing. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

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