Learn › Basics › ETFs Explained
Core conceptExchange-traded funds (ETFs) have quietly become the default building blocks of modern portfolios. They offer instant diversification, low fees, and simple access to almost every corner of global markets—without the complexity of picking individual stocks.
In this guide, we’ll walk through exactly what ETFs are, how they work, the main types, how to compare them, and how to use them to build a simple, resilient portfolio. Whether you’re a total beginner or shifting from mutual funds and stock picking, this is your ETF masterclass.
If you haven’t yet read Investing 101: The Complete Beginner’s Guide, that’s a great “big picture” companion to this page.
An ETF (exchange-traded fund) is a pooled investment that holds a basket of assets—usually stocks or bonds—and trades on an exchange just like an individual stock.
The core idea is that instead of trying to pick winners, you own a diversified slice of the whole “field” and let markets work for you over time.
You don’t need to understand every technical detail to invest in ETFs, but a basic mental model helps you feel confident.
ETFs use a mechanism involving “authorized participants” (APs)—large institutions—to keep ETF prices close to the value of their underlying holdings (net asset value, or NAV).
You don’t see this happening; you just benefit from the result: ETF prices that closely track their indexes.
ETFs and mutual funds are cousins. Both give you a basket of assets, but they differ in how you buy/sell them, what they cost, and how flexible they are.
| Feature | ETFs | Mutual Funds |
|---|---|---|
| Trading | Trade intraday on exchanges | Priced once per day (end of day NAV) |
| Minimums | Often 1 share (or fractional) | Often $500–$2,500+ minimum |
| Fees | Generally lower MERs | Often higher MERs, especially active funds |
| Commissions | May pay trading commissions (dropping over time) | Some have front-end/back-end loads |
| Tax efficiency | Often more tax-efficient in taxable accounts | Can distribute more capital gains |
There are thousands of ETFs, but most fall into a few broad categories. Understanding these helps you filter out the noise.
These hold both stocks and bonds in pre-set ratios (e.g., 80/20, 60/40) and automatically rebalance. They are effectively a one-fund portfolio.
These can be interesting but often carry higher fees and concentration risk. They should rarely be your “core” holdings.
These may play a diversifying role, but most long-term investors build their foundation with broad stock and bond ETFs first.
Not all ETFs are passive. Many are, but some are actively managed or follow complex strategies. It’s important to know which you’re buying.
Even “cheap” ETFs aren’t free. Understanding the main types of costs helps you be intentional.
This is the annual percentage of assets the ETF provider charges to run the fund. It is baked into the fund’s performance—you won’t see a line item, but it quietly reduces returns.
The difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller will accept (ask). Highly traded ETFs have tight spreads; thin, niche ETFs may have wider spreads that add to your cost.
Many brokers now offer commission-free ETF trading, but some still charge per trade. Frequent buying and selling amplifies these costs.
Run your own scenarios with: → Fee Impact Calculator
ETFs are tools. They can be used conservatively or aggressively. The key is knowing what’s inside the ETF and how it fits your plan.
If the overall market falls, a stock market ETF that tracks it will also fall. Diversification can’t remove this risk; it just spreads out single-company risk.
Thematic, sector, or country ETFs can be heavily concentrated in a few companies or industries. This increases volatility and the risk of long periods of underperformance.
ETFs aim to track their indexes, but small differences can occur due to fees, trading costs, and replication methods. For large, broad ETFs, tracking error is generally minimal.
Some ETFs amplify daily returns (2x, 3x) or move opposite the market (inverse). These are trading tools, not long-term investments. Their performance over longer periods can deviate significantly from expectations.
There are thousands of options, but a structured checklist makes selection much easier.
ETFs shine when used as building blocks for a simple, rules-based portfolio you can stick with for years.
Use a single all-in-one asset allocation ETF that holds global stocks and bonds in a pre-set ratio (e.g., 80/20, 60/40).
You choose your own stock/bond mix and rebalance annually or when allocations drift.
For a full walkthrough, see: → Three-Fund Portfolio Guide
Build your portfolio around a small number of broad, low-cost ETFs (the core), then optionally add small satellite positions:
The key is to keep satellites limited so they don’t dominate risk.
To think about allocation more deeply, read: → Asset Allocation Basics
ETFs are generally tax-efficient, but they can still generate taxable income and gains, especially in non-registered or taxable brokerage accounts.
In tax-advantaged accounts (TFSA, RRSP, IRA, 401(k), etc.), distributions may grow tax-free or tax-deferred depending on the account type. In taxable accounts, they may be taxable in the year received.
Where possible, it’s often efficient to hold bond ETFs and high-yield income ETFs in tax-advantaged accounts and keep broad equity ETFs in either tax-advantaged or taxable, depending on your situation.
As ETF markets have evolved, providers have launched more complex products aimed at traders and speculators. These include:
These can behave very differently from what long-term investors expect, especially over multi-month or multi-year periods. Advanced ETFs are tools for traders, not necessary components of a solid retirement portfolio.
New investors sometimes collect ETFs without realizing they hold the same underlying markets. You might own four or five funds that all heavily invest in the same large-cap stocks, creating complexity without extra diversification.
It’s tempting to buy ETFs that have recently “crushed it,” such as hot thematic or sector ETFs. This often leads to buying high and selling low when the trend reverses.
One ETF might charge 0.08% while another charges 0.75% for similar exposure. That difference compounds against you every year.
The ability to trade ETFs intraday is a feature, not a requirement. Using ETFs like trading chips can rack up costs and taxes and often leads to worse outcomes than simply buying and holding.
Leveraged, inverse, or highly niche ETFs can be extremely risky if used as the foundation of a portfolio. For long-term goals, keep the core simple and diversified.
Yes—especially broad, low-cost index ETFs. They offer instant diversification, transparent strategies, and very low fees. Many experienced investors use ETFs as their primary building blocks for life.
You can build a robust portfolio with as few as one to three ETFs. A single all-in-one ETF can work for many investors. A three-fund combination (domestic stocks, international stocks, bonds) is another simple, effective approach.
For broad index ETFs, MERs below 0.25% are common and often much lower. For core holdings, aim for the lowest-cost options that meet your needs. For niche or active ETFs, compare fees carefully and be sure the strategy justifies the higher cost.
It’s very unlikely for a diversified ETF that holds many securities to go to zero, but it is possible for narrow or leveraged ETFs to experience extreme losses. The main risk for broad ETFs is market volatility, not collapse.
Many ETFs do, especially those holding dividend-paying stocks or bonds. You can typically choose to receive cash distributions or automatically reinvest them to buy more units.