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Investing For the Defensive Investor

Index Funds and ETFs

 

What is the difference between index funds, exchange traded funds, and mutual funds? ETFs are a subset of index funds, and index funds are a subset of mutual funds.

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A mutual fund is a basket of stocks, bonds, or other types of assets. This basket is professionally managed by an investment company on behalf of investors. In exchange, the fund charges investors a fee which for actively managed funds may run around 1.80% of assets or more.

 

An index fund is passively managed. Instead of picking and choosing specific stocks that the portfolio manager thinks will outperform, an index fund buys all the shares that make up a particular index, like the S&P 500 index or S&P/TSX Composite index. The aim is to replicate the performance of that entire market. Index funds buy and hold (rather than trade frequently) and require no analysts to research companies so they are much cheaper to operate. Many charge annual fees as low as 0.05%.

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Exchange traded funds (ETFs) are index funds that are listed on an exchange and can be bought and sold just like a stock using a brokerage account.

What is an investor to do?
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Warren Buffett's advice: buy the S&P 500 index each year and hold for the long term. 

How to invest in S&P 500 with ETFs​

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  • Purchase on the TSX stock exchange

    • VFV.TO expense ratio = 0.10%

  • Purchase on the NYSE

    • VOO expense ratio = 0.04%​​

Why buy index funds? 
Better performance. By definition, when you own all the stocks that make up a market, you’ll earn just “average” returns of all the stocks in that market. This raises the question: Who would want to settle for just “average” performance? As it turns out, plenty of investors around the world. While it’s counter-intuitive, academic research has shown that the higher expenses associated with active management and the inherent difficulty of picking winning stocks consistently over long periods of time means that most actively managed mutual funds that aim to beat the market actually end up behind in the long run.
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Why are index funds not more popular?
Due to their exceptionally low fee structure index funds are not promoted by the financial services industry (banks, brokerages, insurance companies etc). Financial advisors also make little money by recommending index funds to their clients. As a result most investors must discover this great vehicle on their own.

Secure your financial future by getting a little better every day

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