An exchange-traded fund (ETF) is an investment fund that holds a basket of individual stocks, government bonds, corporate bonds, or other securities — all in one purchase. ETFs trade on stock exchanges, offering broader diversification than owning a single stock.
Unlike mutual funds, which tend to be actively managed by humans and priced once a day, most ETFs are passively managed. They track an entire economic sector or index, like the S&P/TSX Composite index or the Canadian bond market, using an algorithm rather than a fund manager's judgment. There are, of course, many exceptions to this rule.
ETFs can be bought and sold during the entire trading day, just like individual stocks. This explains why they're called "exchange-traded" funds — and it's one of several features that distinguish them from mutual funds.
How exchange-traded funds work
An ETF is a pooled investment that holds dozens, hundreds, or even thousands of underlying securities — similar in concept to an index fund. When you buy a share, you're purchasing a small slice of everything the fund holds.
Most ETFs are designed to passively track a specific index — such as the S&P/TSX Composite or the FTSE Canada All Cap — by holding the same securities in roughly the same proportions as the index itself. Because they follow a set formula rather than relying on active decision-making, their management fees are typically lower.
ETFs trade on stock exchanges like the Toronto Stock Exchange (TSX). Their price fluctuates throughout the day based on supply and demand, though it usually stays close to the fund's net asset value (NAV) — the total value of all its underlying holdings divided by the number of shares outstanding.
Types of ETFs
Here are the major asset classes and investment products included in the biggest ETF categories.
Stock-market-tracking ETFs
ETFs that mirror indices like the stock or bond market have attracted the most investment from individual investors. Canada's stock market is heavily weighted toward the financial sector, but you'll find plenty of industrial, material, and energy companies on the list, too.
While the S&P/TSX Composite favours the largest companies, those who seek to diversify their holdings with smaller companies may want to consider ETFs that track different segments. The FTSE Canada All Cap Index, for instance, tracks small-, medium-, and large-cap publicly traded Canadian companies.
Sector-tracking ETFs
If you want to focus on a particular sector of the economy rather than the entirety of it, you may want to invest in sector-tracking ETFs. Two financial research firms, MSCI and S&P, developed a taxonomy of the global economy that locates all publicly traded companies in one of 11 main sectors. They dubbed it the Global Industry Classification Standard (GICS).
The 11 sectors in the GICS are:
Communication services
Consumer discretionary
Consumer staples
Energy
Financials
Health care
Industrials
Information technology
Materials
Real estate
Utilities
You'll find multiple ETFs tracking each of these sectors, as well as their subcategories. From largest to smallest, they are categorised as Industry Group, Industry, and Sub-Industry. So if you want to focus on an area like crude oil companies, there's an ETF for that. MSCI hosts a handy interactive tool that provides an overview of all 11 sectors and their subcategories.
International ETFs
Those who want exposure to international stocks may choose to invest in one of several types of international ETFs, described below.
ETFs that focus on the U.S. economy
There are plenty of ways for Canadian investors to own a small sliver of the U.S. economy. One popular approach is an ETF that seeks to mirror the S&P 500, an index of the 500 publicly traded American companies with the highest market capitalisations. The S&P 500, or other large indexes like the Dow Jones Industrial Average or the NASDAQ-100, naturally favour the largest companies, but there are other options, too. The S&P 400, for instance, tracks mid-cap publicly traded companies, and the Russell 2000 tracks small-cap public companies.
ETFs that focus on economies outside the U.S.
With these ETFs, one purchase will buy you exposure to most economies outside of the U.S. You can also invest in ETFs that track the stock markets of specific countries, like the London Stock Exchange or the Tokyo Stock Exchange.
ETFs that focus on developed markets outside the U.S.
Developed markets are the markets of countries that have well-established economies, generally an established rule of law, and are technologically advanced relative to other countries in the world.
ETFs that focus on emerging markets
Emerging economies — like those of Brazil, China, India, and Turkey — are countries with relatively low per capita average salaries that are less politically stable than developed markets, but are open to international investment. Though investing in emerging markets tends to be riskier than developed ones, the risk is somewhat mitigated when an ETF invests across many emerging markets.
ETFs that focus on the economy of one country outside the U.S.
There are multiple ways to invest in any economy. If you've read about how difficult it is to buy some individual foreign stocks, you may decide it's preferable and easier to buy an ETF that focuses on that country.
Thematic ETFs
Thematic ETFs focus on specific trends, ideas, or values rather than a broad market index. Some invest only in companies that meet environmental, social, and corporate governance (ESG) criteria — also known as socially responsible funds. Others target emerging trends, launching new funds as certain sectors gain momentum.
Complex ETFs
Some ETFs use strategies beyond simply tracking an index. Leveraged ETFs and inverse exchange-traded funds use financial instruments like derivatives to amplify returns or profit from market declines. These products carry significantly more risk and are generally designed for experienced investors who understand how they work.
Benefits of investing in ETFs
ETFs have become one of the most widely used investment vehicles in Canada for several reasons.
Diversification: A single ETF can hold hundreds or thousands of securities, spreading your risk across many companies, sectors, or countries. Learn more about how diversification works.
Lower fees: Because most ETFs are passively managed, their management expense ratios (MERs) tend to be lower than those of actively managed mutual funds.
Flexibility: ETFs trade on exchanges throughout the day, so you can buy or sell shares whenever the market is open — unlike mutual funds, which are priced once at the end of each trading day.
Transparency: Most ETFs publish their holdings daily, so you can see exactly what you own.
Accessibility: There's no large minimum investment required. You can start with as little as the price of a single share.
Risks and considerations
Like any investment, ETFs carry risks worth understanding before you invest.
Market risk: If the index or sector an ETF tracks declines in value, so will your investment. Diversification reduces but does not eliminate risk.
Tracking error: An ETF may not perfectly replicate the performance of its benchmark index, resulting in small differences in returns over time.
Liquidity: While most widely traded ETFs are liquid, some niche or specialty ETFs may have lower trading volumes, which can make it harder to buy or sell shares at the price you want.
Currency risk: If you invest in an ETF that holds foreign securities denominated in another currency, exchange rate fluctuations can affect your returns — even if the underlying investments perform well.
ETFs vs. mutual funds
ETFs and mutual funds both let you invest in a diversified basket of securities, but they differ in a few key ways.
Trading: ETFs trade on stock exchanges throughout the day at fluctuating market prices. Mutual funds are bought and sold at the fund's NAV, calculated once at the end of each trading day.
Management style: Most ETFs are passively managed, tracking an index. Most mutual funds are actively managed, with a portfolio manager selecting investments with the goal of outperforming a benchmark.
Fees: ETFs generally have lower MERs than mutual funds, largely because passive management costs less than active management.
Minimum investment: ETFs have no minimum beyond the cost of a single share. Many mutual funds require a minimum initial investment, which can range from a few hundred to several thousand dollars.
How to buy ETFs in Canada
Open a brokerage account. You'll need an investment account with a brokerage. In Canada, you can hold ETFs in a tax-free savings account (TFSA), a registered retirement savings plan (RRSP), or a non-registered (taxable) account. Not sure which is right for you? Compare RRSPs and TFSAs.
Choose your ETF. Consider what index the ETF tracks, what securities it holds, its MER, and its historical tracking accuracy. Think about whether you want broad market exposure or something more focused, like a specific sector or region.
Place your order. You can place a market order, which buys at the current price, or a limit order, which lets you set the maximum price you're willing to pay. Limit orders give you more control, especially for ETFs with lower trading volumes.
The type of account you hold your ETFs in affects how your returns are taxed. In a TFSA, all growth and withdrawals are tax-free. In an RRSP, contributions are tax-deductible and growth is tax-deferred, but withdrawals are taxed as income. In a non-registered account, you'll pay tax on dividends and capital gains in the year they're received or realised.
The bottom line
Exchange-traded funds offer a straightforward, low-cost way to build a diversified investment portfolio. Whether you're looking for broad market exposure or want to focus on a specific sector, region, or theme, there's likely an ETF that fits your goals. By understanding how they work, what they cost, and where the risks lie, you can make more informed decisions about how to put your money to work.
