An Exchange-Traded Fund (ETF) is an investment fund that trades on stock exchanges like individual stocks. ETFs combine the diversification benefits of mutual funds with the real-time trading flexibility of stocks, allowing investors to buy and sell throughout the trading day.

Key takeaways

• ETFs are investment funds that combine the diversification benefits of mutual funds and trading liquidity benefits of stocks. ETFs can be traded on stock exchanges throughout the day.
• They can hold a mix of different assets:  Think stocks, bonds, commodities or even cryptocurrencies, depending on the ETF’s focus.
• There are many different types of ETFs, including ones that focus on specific asset classes (e.g. equities), industries (e.g. technology) or geographic regions (e.g. North America, Asia).
• They can also be categorized by investment approach. The two most common are index-tracking ETFs and actively managed ETFs.
• Investors can trade ETFs through an investment advisor or independently via online brokerage platforms in Canada.
• An ETF holds a basket of investments when you purchase an ETF, you own a slice of everything in that basket — whether it’s stocks, bonds, or other assets.

ETFs are similar to mutual funds because they both hold a diversified mix of investments. The key difference is that ETFs trade on a stock exchange, just like stocks. Here’s a quick look at how they compare.

Today, there are more than 1,800 ETFs listed on the stock exchanges in Canada.  Generally, ETFs can be classified according to what type of investments the ETF holds and the strategy used to achieve its stated investment objectives.

Types of ETFs by asset class and investment theme

• Asset classes: Equity, fixed income, commodity, asset allocation (holds mix of assets)
• Market sector: Information technology, Consumer Staples, Financials, Energy, etc.
• Investment themes: Artificial intelligence, clean energy, sustainability, value, factor
• Geographic regions or country: North America, International, Emerging Markets, Japan, United States, etc.
  
  

ETF investment strategies: Index-tracking vs Actively managed

Index-tracking strategy: These ETFs are designed to mirror the performance of a specific market index. To do this, they invest in the same or similar basket holdings that make up the index.

Popular broad-based market indexes that are traditionally tracked include:

• the S&P/TSX Composite Index: an index that tracks the performance of 200+ listed Canadian companies
• the S&P 500 Index: a stock market index in the U.S that tracks the stock performance of the leading 500 companies in the United States.
• the Nikkei 225 Index - the stock market index in Japan that tracks performance of the leading 225 Japanese stocks).

Active approach:

Actively managed ETFs hold a customized mix of securities chosen by a professional investment team. Unlike index funds, which seek to track a specific benchmark, active ETFs seek to outperform a benchmark by selecting securities from underrepresented sectors or regions, or that the portfolio managers believe offers better upside potential or downside protection.

How ETFs work

When an investor buys an ETF, they instantly own a proportional share of every security in the ETF. Here’s how this works:

1. Purchasing an ETF
   Investors buy shares of an ETF via stock exchanges, like buying a stock. Each share represents fractional ownership of a basket of underlying assets (e.g., equities, bonds, or commodities).
2. ETF pricing
   ETF prices fluctuate during trading hours, reflecting real-time changes in the value of the underlying assets.
3. ETF ownership
   Holding an ETF means proportional ownership of all assets within the fund. Income generated by the underlying securities (e.g., dividends or interest) is distributed to ETF investors.
4. Selling ETFs
   ETF shares may be sold at any time the stock exchange is open.

Benefit of investing in ETFs

As with all types of investments, investors who are interested in including ETFs in their portfolio mix should ensure it fits their overall investment strategy.  Some of the benefits of investing in ETFs include:

Diversification

ETFs diversify your portfolio by spreading your money across many investments. Some assets may rise while other fall, so this can help provide a smoother investment experience.

Portfolio transparency

With ETFs, investors know exactly what they are investing in. ETFs typically provide regular reporting that shows  what securities the fund holds and how it’s performing

Easily bought and sold

ETFs trade on stock exchanges, so you can buy or sell whenever the market is open, providing unitholders with liquidity.

Low fees

ETFs typically come with lower management fees than many investments, but investors should also consider trading costs when buying or selling the funds.

How to buy ETFs in Canada

Investors have two simple options to get started:

1. Do-it-yourself: Open an account with an online trading platform.
2. Guided Approach:  Work with a professional investment advisor who can guide your ETF choices.

When to Buy and Sell ETFs: Timing Tips

While there’s no single "best time" to buy ETFs, here are smart timing tips to consider:

1. Avoid volatile markets: ETF prices can swing wildly during big news events (like economic reports), widening the gap between buying (ask) and selling (bid) prices. Use limit orders to set your maximum buy price or minimum sell price, ensuring you trade at comfortable levels.
2. Steer clear of market open/close rush hours: The first and last 30 minutes of the trading day are often the busiest and most unpredictable. Prices tend to stabilize afterward as activity calms down.