Why'd they have to go and make things so complicated?
The investment industry has made a lot of improvements for the average Canadian over the past couple of decades. In many ways, investing in the stock market has become easier. But simpler? No. The proliferation of new products has made things complicated. Thankfully, cutting through the complexity isn’t hard – you just need a strategy.
Mutual funds and exchange-traded funds have helped make the stock market accessible for more people - someone with no investing expertise get instant access to hundreds of stocks and bonds by buying just a few funds, resulting in a diversified portfolio that will generate a higher return than a savings account over the medium to long term. Big win!
Of course, these products and services aren’t offered solely for the benefit of investors: there’s a profit to be made. Financial institutions continuously add new products to the offering to bolster their sales. Creating a new product attracts new customers, helping to gain market share, and could command a higher fee – just like a regular release of new drink creations does for Starbucks.
The implicit simplicity of buying a mutual fund or ETFs seems to be buried under the complexity of the number and types of products offered. There’s just too much choice.
At the end of 2021, there were 4,262 mutual funds and ETFs in Canada offered by almost 140 fund companies. Last year, 181 net new products were added to the market – that’s new products minus those that were decommissioned. Investors and their financial advisors are being inundated with new products every year. How can anyone keep up and sort through the options?
Arguably, some products have benefits that will appeal to certain people. Products with some kind of guarantee might appeal to lower-income or very conservative retirees. High-dividend funds might be attractive to people who need a stream of income paid into their accounts on a regular basis. But for most people, simple, run-of-the-mill investment funds do the trick.
Cutting through the confusion
So how can you cut through the complexity and figure out what funds to invest in? For do-it-yourself investors, exchange-traded funds are the cheapest and simplest products to own. Here are three concrete things you can do when choosing which ETFs to own.
1. Invest in funds that mirror a broad market index. By choosing to own ETFs that follow a broad market index, you can quickly narrow down your choices. A broad market index is one that represents an entire market. For example, the S&P 500 represents the U.S. stock market. A narrow index focuses on a sub-set of the market; examples include a real estate index or a commodity index. Sticking with the broad-market funds means you don’t have to try and predict what sectors will do better than others (something even the pros struggle with). How do you find these? A Google search for “S&P/TSX Composite Index ETF” will get you a short list of choices for investing in the Canadian equity market. Scroll past the ads and you’ll see offerings from Blackrock (iShares), Horizons ETFs, and BMO. Which do you choose? Honestly, it doesn’t matter much – they are all so similar that any of the big ones will do.
2. Use unbiased “Recommended” lists. Every year, MoneySense produces a list of ETFs that a panel of experienced investors and advisors have chosen as the best ETFs available in Canada. This panel gives serious thought to the list and considers many aspects of the funds. The list contains 26 funds across four main categories (Canadian Equity, US Equity, International Equity, and Fixed Income) and investors can use it as a short-list of the funds they choose from. There are other recommended lists out there – just make sure you understand who’s compiling the list to be aware of any biases in the choices.
3. Choose recognizable names, a passive approach and low fees: More than 40 companies offer ETFs in Canada and this adds to the complexity. To make it easier to choose, stick with the big companies or ones you’ve heard of. Not to say there is anything wrong with the smaller providers but it just keeps it manageable for you by choosing the bigger ones. Second, stick with passively-managed funds. To find out if a fund is passively-managed, go to the website of the provider to get the fund description. The description will say something like: “This fund aims to replicate the performance of the S&P/TSX Composite Index.” Or “This fund provides exposure to the S&P 500 Index.” Third, if you have the choice between two similar funds, choose the one with the lower fee. In the ETF world, cheaper doesn’t mean lower quality. It usually means the provider is big and has economies of scale and can therefore offer a lower fee.
Don’t let the complexity and sheer number of funds overwhelm you. Choose one broad-market fund for each asset class, stick to the well-known ETF providers, and choose the ones with low fees. Or, even easier, choose an all-in-one ETF, also called asset allocation ETFs, which does the work of choosing for you.
Get invested. Keep it simple. Reap the benefits.