1. Try the new Globe Investor beta site

    We're building you a new Globe Investor that is smarter, faster and easier to use.
    We'll be rolling out new sections, features and tools over the coming months.

Skip navigation

Funds and ETF's
ETF rule: Keep it simple

Don't fall for complex, expensive exchange-traded funds

TF rule: Keep it simple

Globe Investor Magazine, March 24, 2009

Indexing is a simple low-cost way to obtain a diversified investment portfolio which tracks the markets. At least that's the theory. Problem is, many investors get led astray. Before they know it their portfolios become jam-packed with the new breed of expensive and risky exchange-traded funds. What was once a solid investment portfolio becomes a speculative one. At its core, index investing is simple, with a goal of investing with the broadest diversification possible.

On this point, though, the investment industry tends to focus on pleasing speculators while doing a disservice to individual investors.

There are relatively few index mutual funds and most of them are pricey. The number of exchange-traded funds (ETFs), on the other hand, has exploded in recent years. Morningstar.com tracks 842 ETFs, nearly 30 per cent of which are less than three years old. On the TSX, there are 81 ETFs trading and most are under three years old. Like mutual funds, ETFs began life as simple products. The first ETFs offered broad exposure to important asset classes and came with rock bottom fees. But popularity attracted competition and many new ETFs embodied bad habits from their mainstream mutual fund counterparts.

New ETFs have become focused on increasingly small slices of financial markets, allowing investors to make bets on specific countries, regions, industries, commodities, and investment themes.

But the theory supporting indexing argues against making such focused bets. What it does support is obtaining the broadest exposure possible to mirror the market, as opposed to engaging in all manner of speculation.

If you buy into the theory that skilled investment managers can't be reliably identified in advance, it seems a stretch to believe that you can pick and choose the sectors that will fare the best in the future. For the index investor, the first lesson is to keep it simple. Use a single index fund, or ETF, to gain exposure to each asset class. An entire indexed portfolio should stick to a total of 10 funds or fewer.


Cost is indexing's primary advantage over active management. It's easy to build a broadly diversified ETF portfolio with a management expense ratio (or annual fee) of 0.3 per cent annually. Yet many ETFs cost more. For every six ETFs in Morningstar.com's universe, one boasts an expense ratio 0.3 per cent or less, one has annual fees north of 0.75 per cent, while the other four lie in between. Fourteen per cent of Canadian ETFs cost 0.3 per cent or less and 30 per cent charge more than 0.75 per cent per annum. This is where investors may be lured into biting the high-fee ETF carrot.

I like the variety of ETFs available. But investors faced with too many choices either feel overwhelmed and sit on their hands, or buy too much of what they should avoid. Many people make poor decisions when it comes to specialty ETFs. For instance, many investors overdosed on commodity ETFs in recent years after being wooed by the China growth story.

There is nothing wrong with commodities; hard assets are a valid portfolio component. But buying something like an oil ETF because everyone is excited isn't investing. It's speculation and it goes against the foundational tenets that support index investing.

Successful indexing comes down to a few simple rules:

Minimize your costs. Aim for all-in fees of less than 0.5 per cent.

Don't get cute with your picks. Resist the itch to attempt to outsmart the market and stick to broadly diversified funds. If you're unsure how to split your investments among stocks and bonds, then a good starting point is to put half into each. Finally, rebalance only when your mix gets out of whack (say by at least 10 percentage points) to avoid making decisions driven by fear or greed.

These rules should serve index investors well over time.

Special to The Globe and Mail

Five emerging markets blue chip picks »
Cuba: An opening, but no day at the beach »
Brazil makes a strong recovery »
What retailers to buy in a slow economy »
Uranium a hot commodity as nuclear demand grows »
A mid-cap pick with impressive management »
Down (and betting) on the farm »
One good idea: Onex, flush and no debt »
How best to play the oil game? Head offshore »


Bullish on Southwestern »
Bullish on Richmont »
Which sectors will lead the rally? »
Bonds are the place to be »
A complex product for playing or hedging currencies »
One way to add yield to your portfolio »
Is the yield part of your portfolio working? »
A limited-time, golden opportunity in bonds »
One good idea: Buy a bond fund that delivers equity-type returns »
Annuities: High returns, but at a stiff price »
One good idea: Buy health care income trusts »
Low Quality Losers: Not a Formula for Long-term Success»
Invest in real assets early in life »
Just focusing on being 'rich' doesn't guarantee personal success »
By global standards, U.S. economy is in decent shape »
Chinaís stimulus spurs investing options »
End of 'home bias' boosts foreign stocks »
The art of ignoring the pendulumís swing »
A value investor on the hunt »
How a bottom-up stock picker gets the job done »
Portfolio too aggressive for Jack's age »
ETF rule: Keep it simple »
Triple-leveraged ETFs not for the faint of heart »
A mutual man strikes back »
Five options for the comeback kid »
One Good Idea: Buy HBP Financials Bull Plus ETF »

Back to top