There are plenty of ways to invest your money to grow wealth over time. Some of the more popular channels include real estate, stocks, and mutual funds.
But another popular investment vehicle to consider is index funds. What exactly are they? Read on to find out why this investment route may be something you should consider investing in and where you can find some of the best index funds in Canada.
Key Points
- Index funds replicate various financial market indexes, which are benchmarks of various securities selected according to an objective and transparent methodology.
- Index funds offer diversification, lower management fees, and passive investment opportunities.
- The best index funds in Canada are those with low MER, low purchase prices, and healthy dividend payouts.
- You can purchase index funds from an online broker, financial advisor, or directly through the fund issuer.
What Is An Index Fund?
An index fund is a form of mutual fund or exchange-traded fund (ETF) that replicate a financial market index.
Since your money is spread across several companies within an index, you can effectively diversify your portfolio rather than focusing on a small number of stocks. This can help to hedge against risk. Furthermore, there’s little need to be concerned about beating the market or choosing “winning” stocks that will outperform the annual growth of the market.
This type of investment allows investors to take a more passive approach to investing but with lower costs than an actively managed fund. Index funds follow specific preset rules for the fund to accurately track a particular basket of investments.
What Are The More Popular Benchmark Indexes?
Some of the more common benchmark indexes include the following:
S&P 500
The Standard & Poor’s 500 (S&P 500) is a stock market index that tracks the performance of 500 large companies listed on US stock exchanges.
Dow Jones Industrial Average
This index measures the performance of the 30 largest firms listed on US stock exchanges.
NASDAQ
The NASDAQ Composite is a New York-based stock exchange that tracks over 3,000 tech-based firms. It is ranked second behind the New York Stock Exchange (NYSE) in terms of market capitalization of shares traded.
Russell 2000 Index
This index measures the performance of the smallest 2,000 stocks — also referred to as “small cap” companies — with a market capitalization of no more than $2 billion.
Wilshire 5000 Total Market Index
This index tracks close to 7,000 publicly traded American companies and is considered the broadest stock market index of publicly traded US firms.
MSCI EAFE Index
Large and mid-cap stocks of companies based in 21 developed countries outside Canada and the US — including those in Europe, Australasia, and the Far East — are tracked by the MSCI EAFE Index.
NASDAQ 100 Index
The NASDAQ 100 Index is composed of the 100 largest non-financial companies listed on the NASDAQ stock exchange. Known for its high concentration of technology and biotech companies, this index includes heavyweights like Apple, Amazon, and Google’s parent company, Alphabet. It provides a clear picture of the performance of the largest innovators and market leaders in the tech sector.
MSCI World Index
The MSCI World Index tracks large and mid-cap stocks across 23 developed countries, covering approximately 85% of the free float-adjusted market capitalization in each. This index is widely used as a benchmark for global equity portfolios, offering investors a comprehensive mirror of the international stock market performance across North America, Europe, and Asia-Pacific.
Bloomberg Aggregate Bond Index
The Bloomberg Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. It includes Treasuries, government-related and corporate securities, mortgage-backed securities (MBS), asset-backed securities (ABS), and commercial mortgage-backed securities (CMBS).
What Makes The Best Index Funds In Canada?
The best Canadian index funds will have the following features:
Low MER
A management expense ratio (MER) is often the main fee investors pay on index funds. As such, the best index funds in Canada have a low MER, which means you won’t be spending more than necessary to have your fund managed.
Not only can a low MER help you save money on fees, but it can also be an indication of the confidence that the manager has in the quality of the index fund. In this case, the fund doesn’t need constant modifications to ensure a healthy return.
Low Purchase Price
You want to be able to comfortably afford an index fund. At the same time, you want to make sure the fund is not too cheap, as this could be an indication of a low-quality fund. Finding out how much an index fund is would be wise before making a purchase.
Dividend Payouts
Index funds that pay out a healthy dividend can be an attractive feature, as they can provide a steady income stream. In addition to making a profit on the sale of an index fund (assuming you sell at a price higher than what you bought it for), you can also earn a profit while you still hold the fund. You can either take the cash or reinvest your dividend payouts into your investments.
What Are The Best Canadian Index Funds?
While there are several index funds to choose from, Canadian investors may find the following popular Canadian index funds appealing:
TD Canadian Index – e
Issued by TD Asset Management Inc. Assets Under Management (AUM), the TD Canadian Index tracks the performance of a widespread Canadian equity market index. It can provide long-term capital growth by measuring the investment return of Canadian securities that are publicly traded.
CIBC Canadian Index
This index fund invests mainly in securities that are part of the S&P/TSX Composite Index, reflecting the Canadian equity market on the Toronto Stock Exchange. Its asset allocation is focused on the financial sector, though other industrial sectors are included.
Scotia Canadian Index Fund
This Canadian index fund invests predominantly in the stocks that are part of the S&P/TSX Composite Index and tracks that index. The index fund also invests heavily in the financial sector, including in RBC and TD Bank. Scotia Asset Management Assets Under Management (AUM) is the index fund’s issuer.
RBC Canadian Index Fund
Issued by the RBC Global Asset Management Inc. Assets Under Management (AUM), this index fund invests mainly in equity securities of firms in Canada to measure the S&P/TSX Capped Composite Total Return Index.
| Index Fund Name | MER | Minimum Investment | Return Since Inception |
| TD Canadian Index – e | 0.22% | $100 | 7.12% |
| CIBC Canadian Index | 1.17% | $500 | 7.3% |
| Scotia Canadian Index Fund | 1.0% | $500 | 6.94% |
| RBC Canadian Index Fund | 0.66% | $500 | 7.8% |
Where Can You Buy The Best Canadian Index Funds?
The main ways to buy the best index funds in Canada are as follows:
Online Brokers
Investors who take a more hands-on approach and like to maintain more control over their investments may prefer to purchase index funds through online brokers. Some of the more popular online brokers include Questrade, Wealthsimple Trade, and Qtrade. Canada’s big banks also offer online investment platforms, such as CIBC Investor’s Edge, RBC Direct Investing, and BMO InvestorLine.
Financial Advisors
Working with a financial advisor to buy an index fund is a great option, especially if you’re a novice investor. Financial advisors can educate and guide you to the right index funds based on your risk tolerance, available capital, and investment goals. Keep in mind that in exchange for this personalized service, you’ll likely be paying higher fees.
Directly From The Fund Issuer
You also have the option to purchase an index fund straight from the fund issuer itself, such as Vanguard, BMO, and iShares. Keep in mind that if you choose this route, you’ll be limited to what the issuer offers.
What’s The Difference Between Index ETFs And Index Mutual Funds?
An index fund can be either a mutual fund or an ETF. For instance, you can purchase an index fund based on the S&P 500 Index either as a mutual fund or ETF. So, what’s the difference? Before choosing an ETF index fund or a mutual fund index fund, consider the following first:
Trading Frequency
How often do you plan to trade your index fund? ETFs are typically better suited for frequent traders because they can be bought and sold throughout the trading day. On the other hand, index mutual funds can only be bought and sold at the end of each trading day.
ETFs also provide current information on the value of the fund investment throughout the trading day, while index funds only provide this information after the trading day ends.
Passive vs. Active Investing
If you’re looking to invest with minimal activity and low costs, then an index mutual fund may be best. Mutual funds are typically passively managed, which means there’s little for investors to do once they’ve initially chosen their fund, aside from regular rebalancing. With less management comes lower fees, too.
Short- Vs Long-Term Investment
If you plan to invest over the long term, then index mutual funds may be best. Since index mutual funds are not bought and sold throughout the trading day, you won’t have to be concerned about piling on transaction costs, which may be the case if you trade frequently with ETF index funds. Instead, if your goal is to hold your investment for a long time, then an index mutual fund may be something to consider.
Pros And Cons of Investing in Index Funds
There are several perks to investing in index funds, but there are also some drawbacks to consider as well. Be sure to weigh the pros and cons prior to investing.
Pros
There are several advantages of investing in index funds in Canada:
- Lower Management Fees. Index funds are typically more affordable than traditional mutual funds. There are no active management fees to pay, and trade commissions are either very low or non-existent.
- Diversification. You can easily lower your investment portfolio risk with built-in diversification through index funds. These investment vehicles allow you to invest a small portion in several companies represented in the market, which can minimize your risk exposure.
- Low Minimum Investment. You don’t need a massive amount of capital to start investing with index funds.
- Passive Investing. You can easily participate in your market of choice rather than scrambling to figure out which stock to invest in that will outperform the market. Instead, index funds allow you to passively invest while allowing your investment to mirror the market rather than always trying to beat it.
Cons
Consider the following drawbacks before investing in index funds:
- Lower Rewards. Since the risk of investing in index funds is very low, so is the potential reward. Generally speaking, reward potential increases with a higher risk. This type of investing is more on the conservative side, which means that even though you will build wealth over time, it may not happen as quickly as it could with a more aggressive investment approach.
- Low Liquidity. Investing in index funds is a long-term investment strategy. When you invest this way, you go in with an understanding that your money will be tied up for the long haul. Investors looking for quick returns after a short period of time may want to consider other investment vehicles.
- Less Control. Index funds are great for those who like the idea of a set-it-and-forget-it type of investment. However, those who seek more control over their investments may find index funds frustrating, as being tied to a specific index may feel restrictive.
Final Thoughts
Index funds have become popular among investors thanks to their diversity, cost-effectiveness, and ease. They’re especially ideal for novice investors, though veteran investors can also benefit from index funds. If you are looking for a low-risk, passive investment strategy that will help you steadily build wealth over time, then index funds may be right for you.
