Your Guide to ETFs

TLDR (Too Long; Didn’t Read)

ETFs are investment funds that trade like stocks and hold a basket of securities (stocks, bonds, commodities).

Key takeaways:

• Trade throughout the day at real-time prices (vs. mutual funds priced once daily)
• Instant diversification with a single purchase
• Many types available: index-tracking, sector, thematic, active, hedged, leveraged
• Generally low management fees, especially passive ETFs that track indexes
• Risks include: market risk, tracking errors, bid-ask spreads, liquidity concerns
• Great for: building diversified portfolios with flexibility and transparency

What is an ETF?

An exchange-traded fund is an investment product that is similar to a mutual fund in that it holds a basket of securities, which can include stocks, bonds, commodities and cryptocurrency, among other things. ETFs combine the diversification of a mutual fund with the flexibility of stock trading.

Canadians have a long history of inventing great products: ginger ale, peanut butter, Walkie-Talkies, basketball – the list goes on. The ETF, one of the world’s most influential investment products, was created here, too, back in 1990.

Since then, but particularly over the past 15 years, Canada’s ETF market has exploded. Today, Canadian investors hold more than $790 billion in ETFs¹, as of March 2026, up from $35 billion in 2010. Yet, as much as the market has expanded, not everyone is familiar with these products. That’s in part because mutual funds are still the more dominant fund type in the country, with more than $2.5 trillion in assets under management (AUM) as of the end of March 2026².

Let’s start with the basics. Because ETFs trade on stock exchanges, you can buy and sell them any time the market’s open, and the price can fluctuate throughout the day, just like a stock. Mutual funds, on the other hand, are priced one day after market close, even though you can place an order at any time during the day. If the order is made after trading hours, you will receive the next business day’s closing price.

ETFs are often thought of as passive investments because many have traditionally tracked an index (or benchmark), which is essentially a list of selected companies that represent a portion of the market. For example, the S&P 500 tracks 500 of the largest companies in the U.S., while the S&P/TSX 60 tracks the 60 largest companies in the Canadian market. Passive ETFs can also track other assets like bonds and commodities. For these traditional ETFs, whatever’s in the index is also reflected in the fund. That means if the companies in the index go up in value, the ETF typically does too, and if they go down, the ETF can lose value. There are also active options where a manager chooses what goes into the fund instead of just following an index.

We dig deeper into how ETFs work in the following guide.

How ETFs compare to mutual funds

Mutual funds and ETFs are both excellent tools for building a diversified investment portfolio, but they operate in slightly different ways. Understanding these differences can help you make more informed decisions – it all depends on your goals, preferences and circumstances.

Both types of funds aim to give you access to a diversified basket of securities, such as stocks or bonds. This diversification helps reduce concentration risk. The big difference, however, is in how the two are traded, priced and managed.

ETF fees explained

Investors have gravitated toward ETFs in part because of their low fees. That’s especially true for passive ETFs. They track an existing benchmark, so they don’t need a professional manager to choose their investments. Fees can be higher for active ETFs – where a fund manager is involved in security selection – or more niche products. Here’s how the fees are broken down.

• What is a management expense ratio (MER)? A fund’s MER, also known as the expense ratio, is the annual fee that all funds charge shareholders for holding the fund. Expressed as a percentage of assets under management (AUM), the MER captures the management fee, operating expenses and taxes incurred by a fund each year. Operating expenses can cover items such as fund valuation costs, audit and legal fees, and costs related to prospectuses and annual reports. The MER doesn’t include sales commissions you may pay, or the fund’s trading costs. A fund’s prospectus will offer more information.
  
  
• What does a management fee cover? The management fee is an annual fee payable by the fund to its manager. This fee forms the largest portion of the MER. It represents the costs shareholders paid for the fund’s management and distribution over the past fiscal year. These include custodian and valuation agents, registrar and transfer agents, and any other service providers retained by the manager.
  
  
• Do ETFs have trading commissions? Since ETFs trade like stocks on an exchange, they are subject to commissions when bought and sold. While most ETFs have the same commission as stocks, at RBC Direct Investing, over 50 ETFs are eligible for commission-free trading.* To learn more about these ETFs, click here.
  
  
• Are ETFs taxable? While taxes are not a fee per se, it’s important to understand how they apply to ETFs. If you hold an ETF in a non-registered account and realize a capital gain when you sell your fund, or if the ETF distributes capital gains at year end, you will have received taxable capital gains that must be included in your total taxable income. If you receive dividends, interest or other ordinary income from your ETF, they would also be considered taxable income. Some distributions may be classified as a return of capital (ROC), which is not immediately taxable but reduces your adjusted cost base (ACB) and affects future capital gains when you sell

What about registered accounts? You generally won’t pay Canadian income tax on ETF distributions or growth while the ETF is held inside a registered account However, foreign withholding taxes may apply to foreign-source income earned through ETFs in a TFSA. In contrast, RRSPs may be exempt from foreign withholding taxes depending on the ETF’s structure and the underlying country’s tax treaty.

What are the benefits of ETFs?

ETFs offer investors several benefits, including:

• Diversification: ETFs are often designed to provide instant diversification. In a single ETF, you can gain exposure to various asset classes, including equities, fixed income, industry sectors and geographic regions
• Low fees: Many ETFs are passively managed, which means they tend to have lower MERs than actively managed mutual funds.
• Flexibility: Because ETFs trade on a stock exchange, you can buy or sell them during the trading day.
• Transparency: All holdings are disclosed daily, so investors can see the portfolio composition of an ETF in a timely manner.
• Portfolio management: Passive ETFs typically involve fewer trades within the fund compared to actively managed ETFs. This may result in lower portfolio turnover, lower MERs and possibly fewer taxable capital gains that must be distributed to investors.

What are the risks of ETFs?

Investors should keep in mind the following ETF risks:

• Underlying asset risk: ETF investors are exposed to any type of risk associated with the underlying basket of investments. For example, a bond ETF is exposed to credit, default and interest rate risks. Look for the risk section of an ETF’s prospectus for detailed explanations of the risks associated with that fund.
• Market risk: The underlying assets of any ETF may fluctuate in value. An ETF that tracks a broad market index, such as the S&P 500, is likely to be less volatile than an ETF that tracks a specific industry or sector. The key is to know what the ETF is tracking and understand the underlying risks associated with it.
• Liquidity: Low trading volume does not necessarily mean low liquidity. An ETF’s liquidity is determined by the liquidity of the underlying securities, whereas trading volume is influenced by the activity of investors. The more liquid an ETF, the smaller the bid/ask spread could be. Conversely, ETFs based on less-liquid underlying assets would have wider bid/ask spreads.
• Tracking error: ETFs that track an index should technically deliver about the same returns as the index, but there can be divergence. Tracking error is the difference between the return an investor receives and that of the benchmark the ETF is attempting to replicate. MER fees are generally the biggest impact here.
• Pricing differences: The market price of an ETF at any given moment may not always accurately reflect the exact value of its underlying assets. Because ETFs trade on an exchange, investors are exposed to market forces when trading. It is possible that prices could diverge from the net asset value, or NAV.

How are ETFs created?

If you’re wondering how ETF shares are created, then this section is for you. First, an ETF provider or sponsor uses authorized participants (APs) to create ETF shares. For example, if a fund is designed to track the S&P 500 index, the AP buys all the stocks in the index in identical weights. The AP then delivers the shares to the ETF provider. In return, the AP receives a “creation unit” – a block of equally valued ETF shares.

APs are typically large financial institutions (such as banks), market makers or specialists. They do most of the buying and selling for ETFs. When there is buying demand (the ETF share price trades at a premium to its NAV), APs create new shares. When there is selling demand (the ETF share price trades at a discount to its NAV), APs process redemptions.

The creation/redemption process is what effectively keeps the price of an ETF’s shares trading aligned with its underlying NAV.

How do ETFs fit in my portfolio?

ETFs are great building blocks for a portfolio because they’re easy to buy, they provide exposure to all of the key indexes you might want to own, and they sometimes offer instant diversification. However, with numerous options and choices available on the market, it's essential to understand how these funds work and how they fit together.

Passive versus active ETFs

When most people think of passive ETFs, they imagine funds that track major indexes, such as the S&P/TSX 60 or the S&P 500. Nearly every major index is tracked by some provider, whether in Canada or elsewhere. There are many other types of index-following ETFs, including the numerous sector ETFs available on the market. Some companies have also developed indexes from scratch around certain themes, plus ETFs that track them.

Active ETFs are like a hybrid between mutual funds and ETFs. Like the latter, they trade on a stock exchange, but like the former, a fund manager chooses the securities that go into the fund. Active ETFs enable companies to offer investments that may not be available through a passive option.

Here’s a quick look at some of the differences between the two types of ETF styles.

Having a mix of passive and active ETFs could allow investors to build a foundation with index-tracking funds while incorporating active strategies to capitalize on opportunities or mitigate risks that broad benchmarks may overlook.

What are the different types of ETFs?

The ETF market has something for everyone. Investors can now mix and match funds based on their risk appetite, beliefs or investing style. Here are some of the types of ETFs.

• Actively managed ETFs: Among the fastest-growing categories, active ETFs combine professional management with ETF convenience. Some follow specific factors like growth or value, while others have managers selecting securities directly. They may come with higher fees but also aim to outperform benchmarks or manage risk more dynamically.
  
  
• All-in-one ETFs: For investors who prefer simplicity, all-in-one ETFs, also called asset allocation ETFs, bundle global stocks and bonds into a single diversified portfolio.
  
  
• Global and sector ETFs: Investors can gain exposure to specific markets or industries, such as U.S. technology, European equities or energy.
  
  
• Hedged and unhedged ETFs: Currency-hedged ETFs aim to reduce the impact of exchange rate movements on foreign investments. Unhedged funds leave returns more exposed to currency shifts.
  
  
• Leveraged and inverse ETFs: For experienced traders, leveraged ETFs amplify gains (and losses), while inverse ETFs rise when the tracked index or benchmark falls. Both are typically designed for short-term strategies, not long-term investing.
  
  
• Passive ETFs: These securities replicate the performance of a benchmark, whether it be for equities, fixed-income or commodities, and don’t rely on a manager to pick stocks.
  
  
• Thematic ETFs: Designed around major trends like clean energy, artificial intelligence or healthcare innovation, these funds let investors focus on areas shaping the future economy.

Building a portfolio using ETFs

There are many ways that you can create a portfolio with ETFs, but here are a few of the more popular strategies. 

• All-in-one basket: For those who prefer simplicity, all-in-one ETFs combine stocks and bonds in a single fund.
  
  
• Core and explore: This approach pairs core ETFs – broad-based passive funds covering areas like Canadian, U.S. and global equities or bonds – with smaller “explore” positions in areas such as gold, emerging markets or artificial intelligence. The result is a diversified foundation with room to pursue specific opportunities.
  
  
• Couch Potato portfolio: The Couch Potato strategy keeps things simple: buy a few core ETFs, hold them long-term and rebalance periodically. Portfolios are often divided among Canadian, U.S. and international stocks along with a Canadian bond ETF, but there are many ways to tailor the mix to your goals.
  
  
• Target-date funds: These ETFs are similar to all-in-ones in that they hold both stocks and bonds, but they’re geared toward a specific retirement date, like 2048. The ETF automatically adjusts as time passes, for instance, become more conservative as the retirement date approaches.
  
  
• A tactical approach: Some investors take a more hands-on approach, using ETFs to make short-term moves based on market expectations. For instance, if someone believes U.S. financials will outperform, they could temporarily add a sector-focused ETF to capture that trend.

With so many options, it’s important to know what’s inside each ETF and how it fits with your broader portfolio. Consider factors such as diversification, management fees and the provider’s track record. Whether you’re seeking broad market exposure or specific opportunities, chances are there’s an ETF for your investing goals.

How to choose an ETF

When choosing an ETF for your portfolio, consider your investing goals, risk tolerance and timeline. You may also want to read media reports or visit fund company websites, which have fact sheets about the ETFs they offer. This can help narrow down the field.

When looking at individual ETFs, you’ll want to look at things like volume, liquidity, the market price, and fees, all of which you can find in a Detailed Quote. An ETF Screener can help you find ETFs that fit your criteria, or you can search for a specific ETF name or symbol. Let’s examine some common trading concepts in more detail and how they apply to ETFs.

• Volume: ETFs have daily trading volumes, just like stocks do. Volume represents the number of units of that ETF that trade on any given day, which is influenced by the activity of investors, again, like a stock. However, with ETFs, daily volume is often mistakenly used as a gauge for liquidity.
  
  
• Liquidity: Unlike with stocks, low trading volume with ETFs doesn’t equate to low liquidity. An ETF’s liquidity is determined by the liquidity of its underlying securities. If an ETF invests in securities that have limited supply or are difficult to trade, this may impact the market makers’ ability to create or redeem units of the ETF, which in turn may affect a portfolio’s liquidity.
  
  
• Liquidity of underlying securities: ETFs that hold frequently traded assets, such as large-cap U.S. stocks, tend to have higher liquidity and narrower spreads. ETFs holding less liquid securities may have wider spreads.
  
  
• Bid-ask spreads: An ETF’s bid and ask spread – the difference between what you want to sell for and what others want to pay – can be impacted by several factors, including trading volume, market risk and the liquidity of the underlying securities.
  
  
• Cost of assembling and trading: Foreign currency conversions, regulatory costs or taxes can add to the cost of creating or redeeming ETF units, impacting spreads.
  
  
• Trading volume and market impact: Large buy or sell orders may require market makers to purchase significant amounts of underlying securities. This can temporarily widen spreads.
  
  
• Market conditions and volatility: Spreads can widen during periods of market stress or when underlying markets are closed (if London is closed and Toronto is open, for instance), as it becomes harder for market makers to price and hedge positions accurately.

How to find the best ETFs for your portfolio

How can you find an ETF and then dig in to decide if any are right for you? You might start your research by turning to detailed quotes, or searching for either a keyword or an ETF symbol. RBC Direct Investing’s Investor’s Toolkit* also offers powerful tools and resources, such as:

• ETF screeners: Here you’ll find filters that can help you narrow down your options. Choose from predefined screens (including strategies by Morningstar^‡ experts), or create your own from a list of criteria, such as fund family, category, performance and country.
• Easy comparisons: From an ETF screener, you can compare ETFs based on a variety of criteria.
• ETF analyst favourites: Explore favourite long-term portfolio builders as chosen by Morningstar analysts. They look at factors such as expenses, index construction, tax efficiency and diversification. 

A Practice Account, available to all RBC online banking clients, can give you access to these tools to start exploring, too.

ETF FAQs

What different types of ETFs are there?
There’s an ETF for nearly every investing goal – from all-in-one and index-tracking funds to sector, thematic, active, hedged, leveraged and inverse ETFs. Some offer global exposure, while others focus on specific themes such as clean energy or technology.

What are the main benefits of ETFs?
ETFs offer diversification, transparency, liquidity and typically lower fees than mutual funds. Many disclose their holdings daily, so you can always see what’s inside.

What are the risks of investing in ETFs?
ETFs carry the same risks as the assets they hold, such as market, credit, interest-rate or currency risk. Prices can also diverge slightly from the value of their underlying holdings (called tracking error), and spreads may widen during volatile periods.

How are ETFs created?
ETF shares are created and redeemed by authorized participants – usually large financial institutions – who exchange baskets of the underlying securities for ETF units. This process keeps ETF prices close to their net asset value (NAV).

What fees are associated with ETFs?
The main cost is the management expense ratio (MER), which covers the manager’s fee and fund expenses. You may also pay trading commissions when you purchase ETFs, though some ETFs are commission-free^* at RBC Direct Investing.

What affects an ETF’s bid-ask spread?
Bid-ask spreads can widen or narrow depending on:

• Liquidity of the underlying securities
• Costs of trading or currency conversion
• Size of buy/sell orders and market impact
• Overall market volatility or when foreign markets are closed

How can ETFs fit in my portfolio?
ETFs can serve as building blocks for a diversified portfolio. You might choose an all-in-one ETF for simplicity, build a core-and-explore mix with broad and sector funds, follow a Couch Potato long-term approach, or take a tactical stance to capture short-term trends.

Where can I research ETFs?
Use tools such as ETF Screeners, Detailed Quotes and ETF Analyst Favourites in the RBC Direct Investing Investor’s Toolkit to compare performance, costs and holdings – or start exploring with a Practice Account.