You may have heard or read about the benefits of a passive investment strategy built on low-cost index funds. For many investors, a passive ETF is a great choice to meet your investment goals.
The ideal situation to use a passive ETF is when:
You want a low-cost investment
You want to match the returns of market
You want the broader diversification of an index
Historically speaking, index investing has proven to be a great investment strategy. Passive ETFs tracking a major index are low cost and have delivered stronger returns than many mutual funds over the last ten years.
Before purchasing any investment, you will need to determine which asset class, equity or bond, is the most appropriate for your goals and timelines.
What to Look For
Once you have decided that an ETF is the right choice to meet your goals, and determined which asset class to buy – here’s what you should look for when picking a passive ETF:
Take a look at how the ETF or underlying index has performed over a longer time period. We like to look at ten-year performance. This allows us to see how the investment did in bad markets. Calendar year performance is also an effective way to track how an investment performs in different market environments.
Be sure you are selecting an ETF that has a low management expense ratio, or MER. You should not be paying commissions to Buy or Sell an ETF.
Low Tracking Error
The tracking error is the difference between the returns of an ETF and that of its benchmark index. Look for ETFs with the smallest possible tracking error.
If you’re investing outside of your RRSP (or other tax-sheltered accounts), you’ll need to pay attention to your ETF’s tax efficiency. Funds that have high turnover likely have less tax efficiency.
Some ETFs have wide spreads between their buy and sell prices. This can happen when the ETF is very thinly traded, or when the fund’s underlying holdings are not very liquid (such as small-cap stocks). Look for ETFs with a narrow bid-ask spread to lower costs.
It is always good to get a second opinion when selecting an investment, so be sure to check with your advisor or an industry expert before purchasing an investment.
For McVean Wealth, I’m Alex McVean.