Exchange-Traded Fund (ETFs) are a bit like a stock and a bit like a mutual fund. Like a stock, you buy ETFs on a stock exchange through any stockbroker or online brokerage account. You can place an order anytime during the trading day. Like a mutual fund, ETFs let you invest in a group of stocks or other investments.
How do ETFs work?
You buy ETFs in units or shares. You can buy or sell any time the stock market is open.
The most common type of ETF holds the same mix of stocks that a stock market index does. In this way, it mirrors, or tracks, the index. If the index or sector your ETF tracks does well, so does your ETF. If the index drops, the price of your ETF will also drop.
Example: Let’s say you buy an ETF linked to an index like the S&P/TSX Composite. That index tracks certain large Canadian companies. Your ETF will do the same.
You may pay less to own an ETF than a mutual fund. Why? Since the ETF just follows an index, the fund manager doesn’t have to do a lot of research about investing. Also, the fund only changes investments when the matching index changes. This doesn’t happen very often, so there isn’t a lot of buying and selling.
How do I make money from an ETF?
The price of your units will go up if the investments the ETF tracks do well, and you will make money if you sell. If they are not doing well, the unit price falls. You will lose money if you decide to sell your units when the price has dropped.
In some cases, the money the ETF makes will be distributed to investors. These payments are called distributions. Some ETFs, for instance, invest in bonds that pay interest each year.
Remember: ETFs can be a simple way to get a good mix of investments.
They’re not like a stock that you have to watch closely every day, although you can if you want to. Many people simply buy ETFs and hold them. They do have some drawbacks, however. They cost more to own than stock, for example. Also, like any investment on the stock market, you may lose money. It depends on the type of ETF you choose and the index it tracks.