Articles

Benefits of Investing in ETFs

Jan 24th, 2012
Quick and cost-effective diversification

ETFs provide a wide choice of investment options, including asset class, geography, sector and investment strategy. ETFs typically track the performance of specific benchmark index. The benchmark can be made up of individual stocks, bonds or other securities therefore, owning a few ETFs can be an easy way to diversify a portfolio.

Trading flexibility

ETFs trade on stock exchanges so that when you buy or sell an ETF, the price is known at the time of the transaction. Mutual fund purchases and sales in contrast, are processed at the end of each trading day, based on their net asset value (NAV) and therefore an investor is unaware of the price when the transaction is placed. ETFs are designed so that they trade close to the value of the underlying stocks in their "basket". This provides greater assurance that the price of the ETF will reflect the value of the underlying assets, although in certain market conditions this may not be the case.

Transparency

ETFs report their holdings every day and typically disclose the specific weighting of the constituents of the tracked index. In contrast, most mutual funds report their holdings periodically - typically quarterly or semi-annually so an investor may not the specific holdings of the Fund when they purchase the Fund. The transparency inherent in ETFs, with the tracking of a specific index, assures the investor that the ETF will maintain its investment strategy.

Cost effectiveness

Like all funds, ETFs have an annual fee referred to as a management fee (MER). But because ETFs are able to achieve lower operating costs, the fee charged by ETFs is generally lower than that charged by mutual funds, and certainly lower than the expense of holding all of the individual stocks directly, making ETFs cost-effective. The understand the full cost of ownership, an investor should include all brokerage commissions applicable when buying or selling all products including ETFs.

Tax efficiency

ETFs are generally more tax-efficient than some other financial products because they rarely generate capital gains. This is mainly because the turnover of the underlying portfolio lower - particularly with index based ETFs - but also because ETFs have a unique tax efficient "in kind" redemption process which minimizes taxes. The ETF investor would generally only pay capital gains tax when the units are sold.

Note that some ETFs also offer dividends or other distributions on a regular basis. These distributions are taxable if held in a non-registered account.

Lower volatility and reduced risk

The price of a stock can change dramatically throughout the day due to company news, economic factors and other global events, however because of ETFs inherent diversity they generally have lower price volatility than the individual stocks. The overall price movement of an ETF is dependent on the movement of all the holdings in the fund.


Originally published on Advisor.ca

What You need to know About ETFs:
http://www.advisor.ca/news/etfs/an-advisor%e2%80%99s-guide-to-etfs-66847

Adapting to Changing Needs:
http://www.advisor.ca/news/etfs/adapting-to-changing-needs-66221

Improving Pensions with ETFs:
http://www.advisor.ca/news/etfs/improve-pensions-by-aiming-for-a-percentage-of-salary-61904

Are MFDA Advisors missing Out of ETFs:
http://www.advisor.ca/news/etfs/are-mfda-advisors-missing-out-on-etfs-65828