hey guys it's Adrian here the Canadian in a T-shirt and today I'm gonna be breaking
down what is an ETF and why ETFs are the best way to diversify your portfolio all
your life you might have been told that mutual funds are the best way to
diversify your portfolio but they can cost you tens of thousands of dollars in
the long run next week I'll discuss why I avoid mutual funds but for this video
I want to focus on why it's so important to diversify and why ETFs are the best
way to do this especially for young investors this is the fourth chapter in
my Millennial Investing Guide so check out my past videos where I broke down
the basics of investing and the difference between stocks and bonds to
understand ETFs you'll need to understand the basics of
the stock market so click the pop up at the top right to check out that video
first the main benefit of ETFs is to diversify your portfolio that basically
means don't put all your eggs in one basket you don't want to have all your
money invested in one industry or even worse in one single company let's say
you love the energy sector because those companies pay great dividends so you
invest all your money in energy companies and then one day the price of
oil plummets and now all of your energy companies take a huge hit and so your
entire portfolio has suffered or worse what if you had invested your entire
retirement fund in a single company say you chose a secure and established
company like Sears or Nortel even giants like these can fall and when they file
for bankruptcy you've just lost your entire retirement fund so it is much
safer to invest in multiple companies across different sectors that way even
if one of the companies you're invested in takes a hit you'll be protected
because your other investments should be growing in value your stocks will go up
and down in value every day but it is extremely unlikely for all of your
stocks to drop at the same time especially if they're diversified across
multiple industries for example if there's another housing market collapse
your investments in banks and real estate through REITs will probably take
a hit but your investments and telecommunications grocery stores and
the technology sector will be doing fine and might even grow and so your total
portfolio will be unharmed if you see my video on the top three best Canadian
dividend stocks you know that I am a huge fan of TD, Enbridge and RioCan but
even so I would never put all of my money in just these three companies
I make sure to invest in multiple companies across different sectors how
do you actually do this how do you diversify especially if you have a
limited amount of money you could do this by choosing one or two companies in
each industry and buying stocks from them so let's say I want to invest in TD
and BMO to cover the financial sector Loblaws for groceries Fortis and hydro
one for utilities RioCan for real estate Microsoft and Amazon for tech and
Bell and Rogers for telecommunications and now I want to buy stocks from these
10 strong companies but here's the thing every time you buy or sell a stock you
will pay a commission fee on that trade usually between $5 and $10
depending on your broker let's say I have $1000 to invest I want
to diversify my portfolio so I want to buy stocks from these 10 different
companies I'm making 10 different trades so my broker will charge me
commission ten times that's $100 down the drain from my original $1000 so
right off the bat I've already lost 10% of my investment through
commission fees all in an effort to diversify here's another issue you can
only buy a whole number of stocks you can't buy a fraction of a share the
problem is a lot of the best blue chip stocks out there are really expensive so
if you want to invest in Amazon for example you only to spend over $1700
$1700 to buy a single share of Amazon you can't buy half a share of
Amazon so if you only have $1000 you won't be able to invest in
Amazon and so you'll be missing out on one of the biggest companies in the
world this is where ETFs come in ETFs and mutual funds are a collection of stocks
and bonds all packaged together into a single fund ETF stands for
exchange-traded funds and they're called that because ETFs are bought and sold on
the stock exchange just like stocks when you buy a stock you're buying a unit of
ownership of that company but when you buy a share of an ETF you're buying a
little tiny piece of hundreds of different companies all in a single
trade instead of buying individual stocks and paying Commission dozens of
times you can invest in hundreds of companies in a single trade and so
you'll only pay Commission once by buying an ETF even better if you use
Questrade which is my favorite online broker you won't pay any
Commission at all when you buy ETF remember my previous example where I
wanted to invest in ten diversified companies
Buying individual stocks from these 10 companies would have cost me $100 in
commission but if I bought an ETF that contained these 10 companies and I
bought this ETF through Questrade I would have paid ZERO dollars in
commission versus $100 also with ETFs you can own fractions of a company as
opposed to stocks remember to buy a single stock of Amazon it would cost you
over $1700 but you can buy an ETF like SPY for only $300 and
this ETF contains the largest US companies including Amazon so for $300
you now own a small portion of Apple Facebook Amazon Microsoft and 500 other
huge companies you may be wondering what about dividends? with stocks you own a
small portion of the company and so you are entitled to a small portion of the
profits this is no different when investing in ETF when you own an ETF you
are a small owner in each of the hundreds of companies inside the ETF and
so you are entitled to a portion of all of their profits the only difference is
that if you own multiple stocks each stock has a different dividend payment
date and so you'll receive multiple smaller payments throughout the quarter
with an ETF however all of the individual dividends are collected and
paid out all at once so you'll receive one large dividend every quarter so
what's the catch? well the main downside to ETFs is that
they are not free to own when you buy a stock you pay a commission fee of
$5 to $10 upfront but after that you own that stock without any ongoing
costs and even if you hold on to the stock for 30 years you'll still own
it and it won't cost you a thing but with an ETF and mutual funds you have to
pay someone to manage this fund as long as you hold on to an ETF you have to pay
an ongoing fee called the management expense ratio or MER this fee is a
percentage of the total value of the ETF or mutual fund that you own luckily for
ETFs this percentage is extremely low compared to mutual funds but an
important thing to note is that this fee is not treated like income tax or
capital gains tax you don't pay a percentage of the profit you make you
pay a percentage of the total value that you own so for example if you own
$10,000 in an ETF which has an MER or management expense ratio of 0.06%
every year you'll be charged fee of 0.06% of this $10,000 so
you'll be charged $6 every year even if your ETF remains flat and
doesn't earn you any profit you still need to pay this $6 fee every
single year so it's different from capital gains tax which only charges you
a percentage of your profit you might be thinking $6 out of a $10,000
$10,000 investment sounds like nothing and you're right that's because
ETF charge very very low fees but if you go with the mutual fund instead mutual
funds charge 10 to 50 times higher fees than an ETF does most mutual funds have
an MER of 2% to 3% compared to ETFs which charge between 0.03%
and 0.5% this is a huge difference so holding $10,000
$10,000 in a passive ETF would cost you $6 a year but holding $10,000
$10,000 in a mutual fund would cost you $300 a year
this is how banks get rich and basically rob you through mutual funds even worse
most people don't even know that are paying a fee for their mutual funds or
ETFs that's because the MER is built into the price or value of the fund it's
not like the monthly fee of your checking account or the annual fee of
your credit card this MER never shows up in your monthly statements or in your
list of transactions if it did it would terrify most customers like stocks the
price of a mutual fund or an ETF goes up and down every single day but the place
that you see is the price after the MER has already been taken away you'll never
see the raw actual value of the mutual fund because if you did you'd see just
how much money the banks have taken away from you through management fees over
the years in my upcoming video I'll dive deeper into just how much money you lose
throughout your life because of these management fees and why I avoid mutual
funds so how come ETFs have such a low
management fee compared to mutual funds? that's because mutual funds are actively
managed and most ETFs are passively managed I'll talk more about active
management in my next video where I'll be hating on mutual funds but basically
every mutual fund has a portfolio manager who is constantly adjusting the
fund buying and selling stocks for you in an effort to beat the market
this constant trading and adjusting is called active management and the huge
management feed that comes with mutual funds is the price you pay for the
"expertise" of the portfolio manager incredibly
85% of active managers perform worse than the market so what are you paying
this huge fee for? ETFs on the other hand are passively managed ETFs are not
trying to beat the market they're trying to match the market so with a passively
managed ETF there's no expert portfolio manager
trying to outsmart everyone else on the market ETFs are simply a collection of
stocks used to replicate an index so what do we mean by the market or the
index? an index is a collection of the biggest companies in a given sector or a
given region which represents all of the stocks in that group it's basically like
how a sample can represent the full population so when you hear on the news
that the market dropped 10% last week that means that the combined value of
all of the stocks in the S&P 500 index dropped by 10% the S&P 500 is one of the
oldest and most important indices in the world and it contains the 500 largest
companies in the United States the S&P 500 index represents the entire US stock
market and it contains some of the most valuable companies in the world
companies like Microsoft Apple Google Facebook Amazon and Walmart on the
Canadian side we use the TSX composite index which contains the 250 largest
Canadian companies this index represents the Canadian stock market through the
toronto stock exchange and it contains companies like RBC BMO TD, Enbridge
Bell and Rogers these two indices are just a list of companies you can't buy an
index but what you can do is buy an ETF which tracks the index this ETF will
contain the same companies and in the same proportions as the index and that's
really easy to do you don't need to pay an expert portfolio manager to do that
you just need someone or even a computer program to look up the current index
proportions and then match it there's no decision making or expert insight
involved that's why it's called passive management and that's why the management
fee for ETFs is so low for example the S&P 500 index currently has a Microsoft
as the largest company with 4.4% of the market and Apple as the second
largest company with 4.3% of the market so if I want to invest in the US
stock market as a whole to diversify my portfolio I'll invest in an ETF which
tracks the S&P 500 index such as SPY. SPY is an ETF which
contains these 500 companies and in the right proportions so if I look at SPY's
SPY's holdings I'll see that 4.4% of SPY's worth is in Microsoft and 4.3%
4.3% is in Apple and so this ETF is matching the market and since this ETF
is so easy to set up, manage and update day to day I only pay an MER of 0.09%
0.09% so there you have it that's everything you need to know about ETFs
management fees and how to diversify your portfolio I'll be making a
video soon where I list my favorite ETFs to invest in and check out my upcoming
video where I further prove why you should avoid mutual funds and choose
ETFs instead also I talked a bit about Questrade which is my favourite online
broker since they don't charge any Commission when you buy ETF's
if you want to get started with Questrade click my referral link in the
description box below and you'll get $50 in commission-free trades when
you sign up plus I'll get a small referral bonus thanks for watching guys
and be sure to LIKE comment and subscribe
if you found this video helpful every thumbs up and comment really helps me
build this channel and be sure to hit that Bell icon to be notified of my new
videos every Thursday and let me know in the comments below what are some of your
favorite ETFs? be sure to tune into my next video where I'll be breaking down
exactly how to buy stocks and I'll be doing a live walkthrough of buying
stocks using Questrade thanks everyone and I'll see you guys on the
next episode of the Canadian in a T-shirt bye guys