Passive investors in Canada often appreciate the simplicity of investing in index funds, which track major indexes like the S&P/TSX 60 or the S&P 500. Exchange-traded funds (ETFs) are another popular investment option, providing exposure to a broader range of assets. While there is some overlap between ETFs and index funds, there are also distinct differences and similarities between these two investment vehicles.
ETFs are funds that are traded on major stock exchanges, just like individual stocks. They hold portfolios of assets such as stocks, bonds, or futures contracts, offering instant diversification to investors.
ETFs can track various assets beyond just stocks, including sectors, categories, commodities, bonds, and even other ETFs.
ETFs charge an MER, which is a fee for owning the asset. The MER for ETFs can vary but is generally lower than that of actively managed funds.
ETFs provide the flexibility to trade like individual stocks, allowing investors to buy and sell them throughout the trading day.
Index funds are passive investments designed to replicate the performance of major market indexes, such as the S&P/TSX 60 or the S&P 500.
Index funds typically have a lower MER compared to actively managed funds because they require less active management. This lower cost benefits investors.
Index funds offer diversification by holding a representative sample of the assets within the index they track.
Index funds, especially when structured as ETFs, pay out dividends and allow options trading, similar to individual stocks.
Pros: Instant diversification, easy trading, dividend reinvestment, and exposure to various asset classes.
Cons: Lower long-term gains compared to individual stocks, potential for overlapping holdings in multiple ETFs.
Pros: Set-and-forget simplicity, lower fees, and endorsement by notable investors like Warren Buffett.
Cons: Lower long-term returns compared to some actively managed funds and individual stocks.
In terms of safety, it depends on the specific ETF or index fund. Generally, index funds, especially those tracking well-established indexes, are considered safe investments due to their diversified nature. However, some ETFs, such as bond ETFs, can also offer safety, with monthly coupon distributions providing regular income.
In general, ETFs tend to have slightly higher expense ratios (MERs) compared to traditional index funds. However, index funds often have some of the lowest MERs among any investment option, making them cost-effective choices for long-term investors.
The S&P 500 is a stock index that represents 500 of the largest publicly traded companies in the United States. An S&P 500 ETF replicates this index by holding all 500 stocks within one investment asset. The ETF aims to mimic the performance of the index.
In Canada, if you hold ETFs in a non-registered account, you are subject to taxes on any dividend distributions received. Capital gains taxes apply only when you sell ETFs for a profit.
Similarly, if you own index funds in a non-registered account in Canada, you are liable for taxes on dividend distributions as they are treated as regular income. Capital gains taxes are applicable only if you sell your index fund units for a profit.
