With over 1000 ETFs listed on the Canadian market, it’s easy to feel overwhelmed and get stuck on analysis paralysis. But I’m here to help, so let’s dive into How to Pick an ETF.
Disclaimer – the following is not investment advice it is for information/education purposes only – please seek professional advice specific to you and your goals and financial journey.
Table of Contents
What is an ETF?
But before we get into how to pick an ETF, let’s start with what is an ETF.
An ETF is an exchange-traded fund – essentially a bundle of securities. It could be a bundle of equities (stocks), a bundle of bonds (fixed-income), or a bundle of both. And with all the options out there, it’s easy to see how many ways we can bundle securities.
If you’ve heard of a mutual fund, an exchange-traded fund is similar in overall concept with some differences on the back end with how they are managed and traded.
Exchange-traded funds can be actively or passively managed. Recently, there has been a rise in actively managed ETFs and they now account for 53% of exchange-traded funds in Canada.
But I would argue that passive ETFs are your better option because they will come with lower fees which means more money in your pocket. Especially if you’re a DIY investor.
Why Purchase an ETF?
So, besides the potential of having lower fees (if you pick a passively managed ETF), another advantage of an ETF is its diversification.
Diversification lowers the risk in your portfolio while still aiming for returns – and who doesn’t want that?
With one ETF you could end up owning a small piece of over 13000 companies (for example if holding VEQT). If one of those companies goes down or even goes bankrupt your return will be affected but VEQT won’t go to zero.
Whereas if you owned an individual stock and it went to zero you would lose everything you have invested in that stock.
Now, you could go out and buy 13000 individual stocks and try to manage this all yourself. But that sounds cumbersome and I’m all for keeping your money simple.
ETFs let you have a diversified portfolio for a low management fee (and therefore low headache).
They are also easy to buy and sell (and are therefore very liquid). And depending on how they are set up, ETFs can be tax-efficient.
How Many ETFs Do I Have to Choose From?
There used to be an old Apple commercial when the iPhone came out that had the tagline “there’s an app for that”. This is what I think of when I think of ETFs.
With the amount of options available, it seems like there is an ETF for whatever you can imagine – “there’s an ETF for that”!
As of the end of 2024, there were 1497 ETFs listed in Canada. And there was $519 Billion invested within ETFs in Canada. Just in 2024, there were 224 new ETFs listed.
And if you wanted to invest on the American or international markets that number becomes even higher.
To someone just starting to invest, this number can feel extremely overwhelming. But I’m here to tell you, as someone who invests in ETFs, that all of the options are just noise. I can maybe name 10 ETFs and invest in less than that. And my portfolio is diversified and performing quite well (or at least as expected).
How to Pick an ETF
Okay, enough preamble – here’s how to pick an ETF.
Three things will help you decide on how to pick an appropriate ETF for your portfolio:
- Your goal – What are you trying to do with the investment? What is the investment for?
- Your time horizon – How long until you need the income?
- Your risk tolerance – How do you feel/react to volatility? (your willingness to accept risk)
Your Goal
Your investing goals will impact your portfolio and therefore what ETFs you decide to invest in. Someone investing for their child’s education may invest differently than someone investing for their retirement.
Ask yourself – what is my investment for? What do I need this investment to do?
Are you planning on selling securities eventually to live off the income? Or do you want to build a portfolio that supplies you with dividends to live off of and you never want to sell your investments?
Your Time Horizon
The longer your time horizon, typically the more risk you can take on with your portfolio. This is because you have time for your portfolio to recover from a downturn or even a prolonged bear market (depending on how long your time horizon is).
Time also gives you the power of compounding. The more time you have the more your investments have the opportunity to compound.
Someone in their 20s investing for retirement may have a very different portfolio than someone in their late 50s. But depending on their goals – also maybe not.
Your Risk Tolerance
I worked in pro sports for almost a decade, and there were seasons where we did not have a winning record and somewhere we did. And I always remember saying, everyone is friends when we win. You really get to know who you can rely on when things go sideways or bad.
Investing is a little like this too. You may not truly know how you feel about volatility until you see your portfolio drop 5%, 10%, or even 20% in a short time.
Personally, I know that I have a solid Personal Investment Policy Statement so I can ignore any short-term dips in the market.
But, if you’re going to panic sell everything at the first sign of a decline, this will impact what you decide to invest in in the beginning.
Not sure what your investment risk tolerance is? The Canadian government has a short (fun) quiz you can take and it will provide you with a model portfolio based on your responses.
A Note on Risk
As stated above, risk can be decreased through appropriate diversification. While an all-equity ETF may appear “risky” because it’s invested in only equities (which historically are more volatile), if it follows an index chances are it’s more of a “medium” risk. This is due to the vast number of holdings within that one fund.
Putting It All Together – How To Pick an ETF
Once you have taken some time to reflect on the above 3 things to help you pick an ETF, it’s time to narrow down your choices. The answers to the above will help you decide on an asset allocation (or how you want your portfolio invested).
Personally, I think there are some great one-fund solutions out there that will rebalance your portfolio automatically for you. Another advantage of this type of fund is there’s only one thing to buy making it super simple to manage your portfolio.
And over time your asset allocation needs may change and you can change your portfolio to reflect this.
For example, someone who is investing for retirement with a long time horizon in front of them and is okay with risk may have a portfolio of 100% equities, then as they near retirement, they may decide to shift to more of a 60% equities, 40% fixed income type portfolio.
And guess what, there are all-in-one ETFs that do just that for you.
Final Thoughts
My final piece of advice for how to pick an ETF is to ignore the noise. When it comes to investing and the markets there is a lot of noise and distraction.
For example, multiple all-in-one ETFs are extremely similar (they have the same asset allocation), just pick one and be okay with your decision. They all may deviate slightly in their returns, but in the long term, you’re better off being invested than waiting and trying to find the optimal 100% best solution. (spoiler alert – it’s impossible to predict this).
I have a few ETFs in my various accounts in part because I need to clean things up and sell some holdings to move everything into an all-in-one solution.
Always remember, when it comes to your money – keep it simple and you’re more likely to stick with your decisions.
Now you know how to pick an ETF – happy investing!