Looking to kick-start an investment portfolio, but don’t know where to start? A great way to lay the foundations for a diversified investment portfolio is by investing in exchange-traded funds (ETFs).

These financial instruments offer transparent, affordable, and liquid access to a wide range of assets, which can include stocks, bonds, commodities, and even cryptocurrencies.

By using ETFs as the core of a portfolio, investors can ensure a baseline level of diversification before they start dabbling with individual stock picks.

 If you’re a beginner when it comes to ETF investing, then this guide is for you. You’ll learn all there is to know about how to buy ETFs in Canada in a step-by-step manner to set you up for success.

What is an ETF?

Exchange-traded funds (ETFs) are open-ended funds that pool the capital of investors to purchase a basket of various underlying securities. Shares of this basket then trade throughout the day on exchanges like stocks do.

Whereas the net asset value (NAV) of a mutual fund is only calculated once a day, ETF prices fluctuate throughout the day as investors buy and sell.¹ On the back end, the ETF sponsor and authorized participant work together to ensure ETF shares can be created and redeemed as necessary.³

Now, ETFs come in many different types. There’s no official taxonomy of ETFs, but a good way to distinguish between them is based on their geography, asset class, and management style:

1. Geography: This refers to the country that the ETF’s underlying assets originate from. For example, an ETF might hold Canadian bonds or Chinese stocks.
2. Asset class: This refers to what type of assets the ETF holds – stocks, bonds, cash, commodities, cryptocurrencies, or even derivatives.
3. Management style: This refers to the methodology by which the ETF picks, weights, and manages its underlying holdings. Passive ETFs track an external index like the S&P 500. Active ETFs use proprietary strategies to try and outperform a benchmark. “Smart Beta” or “Factor” ETFs fall in the middle and use pre-determined quantitative screeners to select stocks.

For example, consider the popular Vanguard S&P 500 Index ETF (TSX: VFV). This ETF would be classified as a U.S. (geography) equity (asset class) passive index (management style) ETF.

How to invest in ETFs in Canada

Investing in ETFs for the first time as a Canadian can seem overwhelming, but it doesn’t have to be. By following these steps, investors can ensure they do their due diligence and avoid making rash or irrational investment decisions.

1.    Open a brokerage account

Because ETFs trade on exchanges like stocks do, the first step is to open a brokerage account. This can be a tax-free savings account (TFSA), registered retirement savings plan (RRSP), or taxable personal account.

Be sure to pick the one best suited to your personal finances and be aware of contribution limits. Our list of top brokerages in Canada is a good place to get some ideas on which broker is right for you.

 If you have a financial advisor, they may also be licensed to trade ETFs on your behalf.

2.    Determine your asset allocation

Different types of ETFs come with different risk/return profiles, especially when it comes to asset classes. For example, stocks tend to be more volatile than bonds, but generally have better performance over long periods of time. Determining the right proportions of each asset to hold relative to another in your portfolio is called asset allocation.

To determine your asset allocation, investors should answer the following questions honestly:

• What is the objective I am investing for? (e.g., retirement, down payment, tuition).
• What is my risk tolerance? (e.g., what percentage of an unrealized loss within your portfolio you are willing to potentially endure).
• What is my time horizon? (e.g., how long will it be before you need to withdraw the money)

There’s no generic answer to the above, but in general, as your objectives, risk tolerance, and time horizon gets lower, your portfolio’s risk should as well. This usually means a heavier allocation to bond or cash ETFs.

3.    Research ETFs in depth

A great way to start is via online screening services. These services allow you to filter for ETFs by various criteria, such as their asset class, geography, management style, fees, and themes. If you have a specific ETF provider in mind, their website may also offer screeners for their own ETFs.

After you have a prospective list of ETFs narrowed down, its time to dive deep. Start with the “ETF Facts” sheet, which provides a basic high-level overview of the ETF’s objectives, top holdings, fees, historical returns and volatility, and overall risk level. This is a great way to assess at a glance whether or not an ETF will be suitable for your portfolio.

If you like what you see, consider diving deeper by examining the ETF’s prospectus, which outlines in detail how the ETF is managed along with detailed statements on possible risks. ETFs will also release periodic management commentary reports, so give those a read too if you want up-to-date professional insights on any ETFs you may be interested in.

4.    Buy your ETFs of choice

Once you know which ETF you want to buy, it’s time to trade. Start by opening your brokerage account and searching for your ETF by typing in its ticker name. For example, if you wanted to buy the Vanguard S&P 500 ETF, you would enter “VFV” as that is its ticker.

Once you’re at the ETF’s ticker page, specify how many shares you would like to purchase. A good practice here is to use limit orders in the middle of the ETF’s bid-ask spread. This can potentially save you money, especially on large trades. You should also be aware of any currency conversion costs.

5.    Manage your ETF portfolio

Once you have all your desired ETFs purchased, it’s time to kickback and manage your portfolio. This mainly involves three things:

• Buying more shares of each ETF in the proportions suiting your asset allocation as you make further contributions.
• Rebalancing your portfolio back to its target asset allocation on an annual, semi-annual, or quarterly basis.
• Reinvesting any distributions paid out by the ETFs held. Some ETFs may offer distribution reinvestment plan participation (DRIP).³

Pros of buying ETFs

As an investment choice, ETFs have some excellent advantages that make them highly popular among both beginner and advanced investors alike, which include:

• Transparency: Most ETFs disclose their holdings daily, which can help investors keep track of what the ETF is invested in.
• Low fees: Compared to most Canadian mutual funds, ETFs tend to charge much lower expense ratios, meaning more money stays in your pocket.²
• Diversification: ETFs can allow investors to gain exposure to a wide array of assets, sectors, and geographies via a single ticker.

Cons of buying ETFs

While ETFs have been revolutionary overall for Canadian investors, they still have some drawbacks to be aware of. Potential disadvantages of ETF investing include:

• Volatility: The risk of an ETF is dependant on their underlying assets. Generally, ETFs that hold stocks, commodities, or cryptocurrencies can be rather volatile.
• Over-diversification: If your goal is to pick specific stocks, then an ETF might be too diversified for your needs.
• Transaction costs: If your brokerage charges for ETF purchases, then you may incur additional trading commissions.

Is investing in ETFs right for you?

Investing in ETFs can be rewarding, but it isn’t for everyone. While a diversified portfolio of ETFs can perform great, investors interested in stock picking might not like this approach.

That being said, investing in ETFs isn’t an all-or-nothing approach. A good compromise is making the core of your portfolio, say around 80%, ETFs, while reserving 20% for some high-conviction stock picks.