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Investing in Index Funds in Canada – Yay or Nay?

We often have conversations with our friends, parents, colleagues, etc. about where we should invest in the stock market. Or asking – I’m a beginner please suggest to me some safe return generating investment ideas, and so. There on one side, we have so-called market experts and on the other side, some genuinely concerned people to show you the reality. 

Guess what, how Warren Buffet answers this tricky question? He says to invest in index funds that replicate the index giving you the diversification benefits and broader exposure. There are various types, advances, disadvantages, technicalities. But rest assured, after the end of this blog, you’ll have better knowledge than you had before. Let’s quickly dive into investing in index funds in Canada?

Read: Your Guide to Investing in Index Funds in Canada!

Know Your Circle of Competence

This is the term used by Warren Buffet. It simply means investing in something you know about. Know which index you want the exposure for. For Instance, S&P 500 gives you the exposure of top 500 firms in the US based on Market Cap, across various industries. Another option could be S&P Dow Jones indices which give you exposure to top 30 companies. If you want international exposure, try MSCI world Index. Ample of options to choose from, and returns await you.

Read: How to Invest in Index Funds in Canada?

Next Comes How to Initiate a Purchase for Your Funds!

Now that you have made the decision of which fund to invest in, you can buy them through an obvious route i.e., through your Broker. However, due to tech disruption, there are many platforms available to invest in. 

With one click you can invest in the fund you want. Some platforms like Robo-advisors give you an automated investment experience of investing on your behalf. But caution should be exercised as more services availed by you will lead to more fees and in the end, it can make a dent in your returns. 

If you choose to invest it by yourself and just avail of the platform services, then your fees can be marginally lower. But if you are a passive investor then you can still manage to have a good night’s sleep than an active investor – who pays huge sums to fund managers to generate market-beating returns. Platforms let you invest in ETFs and Mutual funds from where you can exposure to an Index. Investing in index funds in Canada has never been so easy!

Read: Can You Beat Inflation in Canada?

Do the Cost Analysis

This is a vital due diligence step to be performed before investing through any platform. Compare costs across the brokerages and platforms. Some providers will like your account to be funded with a minimum amount while others have a higher minimum threshold to be maintained. 

The more pressing thing is the commissions and other fees they charge. While index investing is a pocket-friendly endeavor, thorough analysis of broker fees can lead to great returns over the long term, as you let compounding do its work. Cost Analysis can eliminate bumpy roads to return generation in your journey of investing in index funds in Canada.

Read: Top 10 Investment Rules To Follow In Canada!

The Topic of the Day – Should You Invest in Index Funds?

By now, you must have onboard the train of index funds with all the utilities shared above. Every investment product has its own Pros and Cons and index funds aren’t a one-stop solution for every investor in the world. Like people possess different qualities and traits, investment products also have different qualities. Let’s walk through in detail about pros and cons and then you can start aligning yourself with the Index funds.

The Best Part

The biggest advantage of index funds is their low fee structure. Unlike active investing, you don’t need to worry about your fees eating up your returns. After-cost returns are generally in line with market expectations. The reason is, that fund managers in index funds don’t require to keep banging their heads to stay ahead of the markets. Instead, they just mirror the index and chill! 

Read: Your Guide on How to Invest in an ETF in Canada

You are not into choosing individual stocks within a universe of stocks to generate Alpha (Risk-adjusted returns, beating markets). Generally, fees for index funds have been in the range of 0.05% to 0.25% annually, while for active counterparts it has ranged from one to two percent. You see, this is where you make a difference.

Another benefit is if you are a long-term investor, then you participate in the long-term story of the country in which stocks you are investing. However, caution should be exercised about which long-term story you’d want to be a part of. Because not every story has a happy ending.

The word to focus on here is ‘Long term’, which means for a reasonable amount of time. If you’re a short-term investor lacking patience then you might not want to onboard this train. The reason why legends like Warren Buffet back Index funds is because, in the long run, Index funds outperform active investments. 

Go back in history and check the S&P 500 returns generated over some decades. The figure would be easily around 10-15%. You participate in the long ren story of the top companies, so you have all the odds in your favor. The very nature of the stock markets is that in the long run they generally trend upwards, which aids this investment idea. However, as the saying goes – Past performance is no guarantee of future returns.

Read: What Are The Investment Risks You Need To Know In Canada?

The Shortfalls

You must want to know the downside. Here it is – Index funds are a xerox copy of the index, with the fund manager trying to mitigate tracking error. If you are an investor that wants to take advantage of some specific sector, say like Pharma (during Covid-19) you won’t be able to turn the tables. 

As index weights are fixed and you cannot exercise your discretion in order to take advantage of the sector-specific boom. (Of course, assuming you’ve all the information, and make informed decisions) Freedom in selecting stocks is compromised like it was compromised for Indians during British Era.

Initially, you might get frustrated as your returns will not beat inflation while investing in Index funds in Canada. Short term temptation of beating the markets and becoming a millionaire might disappoint you.

Read: 13 Ways on How to Improve Your Finances in Canada

How Many Funds Should You Invest In?

The answer to the above question should be unique to every investor based on their idiosyncratic behavior. Truth be told, index funds try to cover the entire market. Like S&P 500, where you get the exposure of top 500 companies across various industries.

However, if you want to get exposure in different asset classes like fixed income, commodities, real estate, etc. then there are ETFs tailored to fulfill your needs. Automated platforms help you invest in different markets by suggesting pertinent investment opportunities based on your risk profile.

Read: 22 Finance Terms You Should Know in 2022!


Devanshee Dave

Devanshee is a staff writer at YourFirst.ca. She is a finance enthusiast and has completed her Master’s degree in Mass Communication & Journalism. She has worked as a journalist in a local business newspaper, multiple start-ups as well as finance and economy-related online media houses.

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