Fortunately, ETFs, like stocks, are supremely liquid. If you don’t make the best selection at first, you can sell your holdings and replace them with more suitable ones in a matter of minutes.
When it comes to core portfolio holdings—the basic building blocks of a portfolio, such as Canadian, U.S. and international stocks, and Canadian bonds—there are plenty of ETFs to choose from. You can also opt for an asset allocation ETF that combines them all in one fund.
These all-in-one ETFs can use different approaches, from passive index investing to active management, such as the approach used by Fidelity’s actively managed all-in-one ETFs.
With so many similar options from different fund companies, and often several from the same provider, how do you decide which ETFs to buy for a DIY investment portfolio?
A simple plan
Before you begin comparison shopping, you should have an investment plan. It will outline the purpose of the portfolio. What is it meant to fund: your retirement, your kids’ education, a home purchase, or life’s surprises?
How long should you invest in an ETF? Start by considering the time frame between first contributing to the portfolio and when you expect to draw from it.
If it is more than five years, you can consider more volatile but potentially rewarding underlying investments such as stocks.
Also consider your own risk tolerance. Would you be comfortable with your savings losing 20% of their value in a year, knowing that you don’t need the money for a decade or more and it will almost certainly recover?
The classic balanced portfolio for long-term investors was divided into 60% equities and 40% fixed income (the equity portion would be further divided into regions: U.S., Canada, international to maximize the risk-reducing effect of diversification).
A more conservative investor or one on a short timeline might increase the fixed income component; a more aggressive one with plenty of time could amp up the equities. Increasingly, investors are adding non-traditional assets such as commodities and cryptocurrency.
Your asset allocation can have a major impact on your portfolio’s risk and long-term returns, which is why it’s worth settling on an appropriate mix before comparing individual ETFs.
Further, DIY investing does not mean doing it in a vacuum. Ask a fee-for-service advisor or someone you know who’s knowledgeable about investing for a second opinion of your plan.
Key criteria for choosing an ETF
Once you’ve determined the asset exposures you are seeking, you can compare the ETF options within those categories. Here are the most important considerations:
- Exposure to the asset class. Does the ETF hold an index of investments or is it actively managed to boost returns and/or reduce risk? How has it performed lately? If it’s an index fund, what index does it track? How closely has it tracked that index in the past? Are you convinced this is the most suitable methodology for managing your investments? Keep in mind that index funds tend to be cheaper to own than active ones.
- Cost of holding the ETF. Fund companies charge management and other fees, together expressed as a management expense ratio (MER), or percentage of your assets held per year. You don’t get a bill; it’s simply deducted from your returns. Funds with low MERs are effectively cheaper to own. You can’t predict your future returns, but you can know what fees you’ll pay based on the fund’s MER and other costs.
- Cost of trading the ETF. Your brokerage likely charges a fee every time you buy or sell a stock or ETF, but many waive the fees on certain ETFs or fund families, giving these a cost advantage. This will not be an issue if you have a 0% commission brokerage account or one that exempts all ETFs from trading fees.
- Liquidity. All ETFs are liquid in the sense you can buy or sell them almost any time during trading hours. That said, smaller funds may experience larger bid-ask spreads—the difference between what buyers are prepared to pay and what sellers demand—resulting in sub-optimal pricing on the units you buy. One way around this is to stick to ETFs with a high average trading volume.
- Special attributes. Often within a certain fund category, you will have choices around the format or structure of the fund. For example, some ETFs invested in foreign assets hedge their holdings into Canadian dollars to control for currency risk; others don’t. Some ETFs can be held denominated in U.S. dollars instead of Canadian. Some distribute income monthly, others quarterly. Choose the format that best suits your needs and objectives.
Do it yourself, but with help along the way
Most of the fund characteristics listed above will be described in the ETF prospectus and fact sheet on the fund company website, or you can consult the information available from your brokerage, from media outlets or from third-party sites such as Morningstar.ca.
With so many ETFs available, how can investors simplify the decision-making process? One way is to choose an all-in-one ETF that holds a diversified portfolio of asset types in a single investment.
Often called asset allocation ETFs, these are offered by virtually all the leading fund companies in Canada. They come in a broad spectrum of risk/return profiles from conservative funds 80% invested in fixed income to aggressive, 100%-equity funds.
