The amount of money invested in the 500 or so exchange traded funds listed on the Toronto Stock Exchange has topped $130-billion – double the amount invested five years ago.
Most investors are familiar with ETFs but they still pale in comparison to the $1.4-trillion invested in actively-managed Canadian mutual funds.
If you’re not sure if your money belongs in an ETF or a mutual fund, here are the basic differences:
Mutual funds are actively managed. That means portfolio managers select the holdings, set strategies and determine when it’s time to sell and purchase other holdings. Active managers can also implement strategies to hedge against risk in the event of an unexpected downturn in the market.
Active management comes at a price. Annual fees, also known as the management expense ratio (MER), can exceed three per cent. Those fees are extracted from the total amount invested. If the fund does well, fees make returns lower. If it does poorly, you actually pay a manager to lose your money.
Mutual funds are popular among retail investors because they provide diversification no matter how small your contributions. Regular contributions can be made without accumulating trading costs.
Exchange traded funds
ETFs are passively managed. Holdings are pre-selected based on their weightings in an index. When that weighting changes, the holdings change. Basically, the market is your portfolio manager.
As a result, fees are significantly lower, which puts more of the returns in the investor’s pocket. MERs are usually below 0.1 per cent.
On the downside, there is no risk management with ETFs. The investor is exposed to the whims of the broader markets.
ETFs are also much more transparent. Mutual funds are not required to disclose many pertinent details or changes, but ETFs that mimic an index are reflected in that index.
ETFs trade like stocks and generally impose a fee on each trade, which could add up for small contributions.