ETFs (Exchange-Traded Funds) ~ What’s That?

Are you the type of person who likes to learn new things?  The type who finds pleasure in understanding something that is totally foreign?  The type who would try anything once?  Bungee jumping, sky diving, or shark cage diving!  If these activities sound a bit extreme, then you might be open to something more passive than any of these.

Deepening your understanding of investing might be the difference between life and death.  Now this sounds like a harsh statement but maybe not if it means you can afford to put food on your table to prevent you from starving.

At the latest CIFPs Professional Development Day, the discussion was about people who do not want to take risks with their money so they choose the perfectly safe route and put their money into GICs (Guaranteed Investment Certificates). This type of strategy raises a perplexing question, “Are they not putting themselves at risk if they run out of money?”   

Advisors are always taught to understand their clients’ objectives and risk tolerances.  If safety is what clients want, then safety is what they are given.  However, financial advisors and financial planners also have an obligation to educate their clients.  Their clients need to fully understand that holding only safe investments could be dangerous.  Settling for 1% GIC investments returns may not be in their best interests if this means running out of money in their retirement years.  Living destitute would not be “pleasant”.  Dreams of retirement life could be destroyed when the “well” runs dry.

Knowing your options in advance of your retirement date is a plausible solution. During the days when you are accumulating your wealth, you need to decide where to invest your money for it to grow. Having some knowledge is better than having no knowledge about savings and investing.

Previously, we discussed mutual funds in the blog, Investing in the Rise and the Fall of the Markets.  With all the hype in the investment world about transparency in regards to fees, people are beginning to take notice exactly how much they are paying in management fees. I don’t believe the true cost of management fees could ever be determined because the task would be too onerous for mutual funds companies.  Yet here’s the dilemma we, as investors, face.  We are trying to reduce fees and increase returns while we minimize risk.  That sounds like quite an accomplishment to undertake.  

What's the answer? You’ve heard the adage, “Don’t put all your eggs in one basket” known as diversifying your money into bond and equity investments spread over different sectors of the economy and world markets.   Another investment option, which does this and is gaining popularity, is ETFs, exchange-traded funds. These investment funds trade like stocks and derive their value from the markets by riding the coattails of indexes, for example, the S&P/TSX 60 Index. Because ETF returns are mirrored from the performance of an index, technically, the management of the funds is minimal which in turn reduces the fees and expenses.  This strategy is known as “passive investing” as opposed to “active investing” where portfolio managers actively buy and sell securities.

The following excerpts explains ETFs growing popularity. 

The article, The Rise of ETFs, reported that “At the end of 2007, there were only two ETF providers in Canada.  Today, there are 13, including Vanguard, which entered the market in December 2011.  Between 2008 and March, 2016, the number of Canadian ETFs rose to 424 from 77 while AUM (Asset Under Management) increased to $95.0 billion from $19.4 billion.”  

Another article, (Canadian EFT Industry: Why Exchange Traded Funds isn’t the question any longer) points out, “…while the ETF industry here nears the $100 billion milestone, it remains a fraction of the Assets residing in the Mutual Fund space ($1.3 Trillion).”   

The last point about ETFs comes from US analyst Dave Nadig, from Factset. He commented, “I can’t believe how strong fund flows into Mutual Funds still are in Canada…In the US, that ship sailed about a decade ago, with ETFs the beneficiaries of the shift.”  

Here’s your challenge.

If you are unfamiliar with ETFs, make an effort to learn about this popular investment option.  A great amount of education is available from various sources.  My role as your financial planner is to point you in the direction where you gain the knowledge necessary to make an informed decision about ETF investing. Choosing core-type broadly diversified ETFs (notice the lingo) is the same as if I said, choose “plain vanilla, nothing fancy, ETFs”.  The frightening part is another kind of ETFs is wandering into the market place.  Embedded-Strategy ETFs (ESETFs) encompass a broad range of strategies which may lead you down a different path with undesired risks.

This “stuff” isn’t always easy to understand at the onset. The more you immerse yourself in the information, the more you will grasp tidbits that will eventually make sense.  Repetition is helpful.  Exposure to articles, webinars, and conversations with financial advisors and financial planners will increase your understanding.  When you reflect on your life, you will see many things in your past that you didn’t master at the first crack, (riding a bike, using a computer, or driving a vehicle).  Be patient but be persistent. Learn.  

Here are places to learn more about ETFs.

1.   Credential Direct, an online trading brokerage firm, invited Dan Bortolotti, in September, to lead the educational webinar, 7 Steps to the Perfect Portfolio.  Dan is known for his infamous blog posts at Canadian Coach Potato and numerous articles for Money Sense magazine. Dan walks investors through the process of planning, building, and maintaining a low-cost, diversified portfolio of EFTs. You will be grateful for the time invested in this session.

 

2.     Another article worthy of your time is “Make an Informed Decision When Investing in ETFs.” Kevin Rusli, a lawyer, provides a list of five topics to discuss with your financial advisor prior to investing in ETFs.  Kevin is a partner in the Investment Products & Asset Management Group at Blake, Cassels & Graydon, LLP and regularly advises asset managers.

 

3.     I cannot end this blog without adding a book to your homework assignment.  At the onset of the financial crisis of 2008-2009, I recall Danielle Park making her national TV debut and instructing people to “run for the hills”.  Well, that’s not exactly word-for-word what she said. She was advising investors to move from the equity market to cash. The title of her book speaks for itself. Juggling Dynamite provides an inside view of how to protect your investments.  In her book, Danielle Parks opens Chapter 13~~Building and Preserving a Rich Life~~ with a quote from Henry Ford. “If money is your hope for independence, you will never have it.  The only real security that a man will have in this world is a reserve of knowledge, experience, and ability.”   My perspective from this message, “Arm yourself. Learn all you can."