It’s no secret that with the economy today and rising living costs in Canada, it’s crucial to have more than one revenue stream.

If your primary income source leaves you with enough time, it is possible to look for ways to make money online. But I have always found investing your money to earn passive income is an ideal way for Canadians to add another income source to achieve financial freedom.

Canadian investors have a wealth of financial instruments they can choose to invest in to generate passive income. Index funds are an attractive choice for new investors who want to invest their money in established markets to get the returns they need to meet their goals.

This post will be a guide that lists down some of the best index funds in Canada to help you find the right options. But first, I will take a closer look at what they are and how they compare to other seemingly similar financial instruments to help you make a more well-informed investment decision.

What Is An Index Fund?

An index fund is a financial instrument that you can invest your money in to generate passive income. Many people confuse index funds to be the same as either mutual funds or Exchange-Traded Funds (ETFs).

The truth is, it has qualities of both, and you can consider it a kind of hybrid between mutual funds and ETFs that brings you the best qualities of both asset types.

Index funds are assets that can provide you with exposure to a basket of securities that belong to different segments of the market by mirroring specific indexes.

A single index fund’s constituent securities include all the companies included in a particular market index. When you buy an index fund, you effectively buy a small market slice to mirror its growth.

Take any established market index like the S&P An index fund tracking the S&P Index holds all the constituent securities for the underlying index.

When you buy that index, it spreads your money across the entire index, ensuring that it is well-diversified instead of focused on a narrow basket of individual stocks.

If you prefer a passive investing style with a long investment horizon, index funds give you an easy way to invest your capital and see it grow based on the market movement of popular indexes.

The focus is on replicating the market and not beating it. Since your investment has to mirror the indexes, you don’t need to worry about buying individual securities in a bid to beat the market, making investing a much simpler affair.

Before jumping into the list of the best index funds in Canada, it is important to understand how index funds differ from ETFs and mutual funds. If you don't know the differences, see below the list for the full breakdown of ETFs vs index funds vs mutual funds.

The Best Index Funds In Canada

Index funds have been a popular investment tool for many Canadians due to the comprehensive but low-cost exposure to different market segments and relatively stress-free approach to investing.

The rise of ETFs in Canada has led to a decline in the popularity of mutual funds and index funds. There are several excellent ETFs in Canada to choose from, but not many index funds to consider.

Some investors might view that as a disadvantage, but I think it is a good thing because it narrows down the options you have to consider. This section of my guide to the best index funds in Canada will list down the mutual funds you can consider buying today.

1. TD Canadian Index &#; e (TDB)

Some key facts about TD Canadian Index Fund:

• Total Assets Under Management: $ billion
• MER: %
• Dividend Yield: %
• Turnover Ratio: %

TD Canadian Index Fund (TDB) is an index fund that emulates, to the extent possible, the performance of the Solactive Canada Broad Market Index, net of expenses.

The constituent securities for the underlying market index tracked by TDB comprise well-established Canadian companies trading on the TSX. TDB is one of the largest index funds available to trade for Canadians.

2. CIBC Canadian Index (CIB)

Some key facts about CIBC Canadian Index Fund:

• Total Assets Under Management: $ billion
• MER: %
• Dividend Yield: %
• Turnover Ratio: %

CIBC Canadian Index Fund (CIB) is an index fund that emulates, to the extent possible, the performance of the S&P/TSX Composite Index, net of expenses. The S&P/TSX Composite Index is the primary benchmark index for the Canadian stock market.

The constituent securities for the underlying market index tracked by CIB mostly comprise well-established Canadian companies in the financial sector, and it focuses on some crucial industrial sectors.

3. RBC Canadian Index Fund (RBF)

Some key facts about RBC Canadian Index Fund:

• Total Assets Under Management: $ billion
• MER: %
• Dividend Yield: %
• Turnover Ratio: %

RBC Canadian Index Fund (RBF) is an index fund that emulates, to the extent possible, the S&P/TSX Capped Composite Total Return Index, net of expenses.

The constituent securities for the S&P/TSX Capped Composite Total Return Index primarily comprise equity securities of Canadian companies across various sectors of the economy.

Some of the top investments for the fund include the Royal Bank of Canada, Canadian National Railways, and the Toronto-Dominion Bank.

4. Scotia Canadian Index Fund (BNS)

Some key facts about Scotia Canadian Index Fund:

• Total Assets Under Management: $ million
• MER: %
• Dividend Yield: %
• Turnover Ratio: %

Scotia Canadian Index Fund (BNS) is an index fund that emulates, to the extent possible, the S&P/TSX Composite Index net of expenses. The constituent securities for the S&P/TSX Composite Index include all the companies trading on the Canadian stock market.

When you invest in BNS, you are essentially diversifying your investment capital allocated to the fund into the entire Canadian stock market. The underlying index primarily invests in the financial industry, including the Toronto-Dominion Bank and the Royal Bank of Canada.

Pros And Cons Of Index Funds

Index funds have several qualities that make them an attractive asset to consider if you are a first-time investor who doesn’t have a lot of time on your hands and are cautious about investing your money. Of course, not every financial instrument is perfect for every aspiring investor.

Index funds offer plenty of benefits, but they come with their drawbacks. This section of my guide to the best index funds in Canada will discuss the pros and cons of index funds to give you the information you need to make a better decision on whether index funds are a suitable investment for you.

Pros

• Low Cost: While index funds carry a higher fee than ETFs, these funds offer you significant savings compared to mutual fund products. Without fund managers actively rebalancing the fund’s holdings, you do not have to contend with high management fees.

With low to zero trading commissions, an investment portfolio comprising of index funds will typically cost you between % per year. Actively managed mutual funds can cost you % per year.

• Diversification: New investors who do not have a good understanding of how to diversify their portfolios can get a helping hand if they invest in an index fund.

If you are not looking to get market-beating returns and are happy with tracking the growth of a particular market that has been doing well, investing in a corresponding index fund will automatically diversify your funds into those companies across various industries.

• Accessibility: Some mutual fund products require doing a lot of research and paying high management fees to expensive fund managers or financial advisors. With index funds, you can invest in a market that you are interested in without having to worry about which stocks will perform the best.

Index funds let you take on a passive approach to investing by simply mirroring the market instead of trying to beat it. You don’t need to bother with paying a financial advisor to help you make investment decisions or pay high management fees to fund managers.

Cons

• Limited Flexibility: Some investors might appreciate the qualities of index funds that make them ideal long-term investments. But if you are an investor who wants to have more control over what companies you hold in your portfolio, these funds do not give you the flexibility you might prefer.

Similarly, if the index holds companies that you do not like due to their business practices not aligning with your moral values, you cannot do anything about it and have to bear with the investments that the index fund holds regardless of how you feel about it.

• Low Returns: Another quality that makes index funds a good option for many investors is that this asset type typically offers lower capital risk than picking and choosing individual stocks for your investment portfolio to beat the market. This is particularly true if you are an investor with a long investment horizon because buying and holding market indexes for the long haul can help you ride out dips and bear markets. However, as with any investment, the low capital risk comes with low rewards.

Most of the companies held within an index are likely well-established firms that offer consistent and steady but modest growth. You might find it challenging to invest in market segments that you recently developed an interest in because most market indexes focus on well-established companies.

If you find a new high-growth opportunity that you want to dabble in to achieve significant wealth growth through rapid capital gains, it will likely be impossible to find an index fund that holds the asset.

• Lack Of Quick Liquidity: Index funds are ideal as part of a long-term investment strategy. The best way to maximize your return on investment in index funds is to invest in a fund that follows a market of your preference and forget about it for years to enjoy the returns as the market index grows.

Unfortunately, if the market index does not offer wealth growth at rates that you prefer or cannot keep up with inflation rates, you might not meet your financial goals. Additionally, short-term market downturns can impact your returns and leave you in a difficult position if you are expecting short-term returns.

Index Fund vs. ETF vs. Mutual Funds

While index funds bear similarities with ETFs and mutual funds, it’s important to understand that the three are not the same financial products.

Index Funds vs. ETFs

ETFs are similar to index funds because they aim to track specific segments of the market and typically are passively managed. Being a passively managed fund means that ETFs are a low-cost financial instrument because they do not have a fund manager actively rebalancing the portfolio to try to beat the market.

However, ETFs come with more of an affordable price tag that any novice investor with a small initial investment capital can purchase on the stock market. Index funds are similar to mutual funds in that they require a prerequisite of high minimum investments.

You will need to set aside significant money as investment capital to purchase an index fund.

Index funds do not trade on the stock market like ETFs. You can buy and sell ETFs throughout the day on the stock market, but you can only make one trade a day with index funds after the market closes because that is when their price is set.

It means that index funds offer lower flexibility than ETFs when it comes to making quick trades.

ETFs are not limited to tracking market indexes. ETFs also make it easier for you to gain exposure to a decent mixture of different asset types like bonds and stocks. You can buy ETFs that track more diverse market segments, and there are even ETFs that track the performance of commodities like gold and silver.

ETFs are also famous for being accessible due to their lower overall cost. They come with lower investment fees than mutual funds because they are passively managed funds.

Combine that with little to no investment premiums, and you get a financial instrument that is more affordable than index funds. The lowest-cost exposure to baskets of securities has lately made ETFs increasingly popular among Canadian investors than any mutual fund or index fund product.

Index Funds vs. Mutual Funds

Technically speaking, index funds are essentially a type of mutual fund. However, that is where the similarity ends between the two asset classes. Mutual funds are actively managed funds with fund managers responsible for actively realigning the portfolio’s constituent holdings to try and outperform the broader market.

Mutual fund managers regularly rebalance the funds’ holdings by buying and selling assets and reinvesting in different industries and asset types that they believe will give investors greater growth than the broader market.

As an investor who holds a mutual fund product, you might constantly find yourself worrying about whether the fund managers can deliver on the promise of providing you with market-beating returns.

Index funds take a simpler approach to utilize the pooled resources. The fund managers do not try to rebalance the fund’s constituent holdings to try and beat the market based on the assets or industries that they think can offer market-beating growth.

Instead, they simply compose the fund with all the constituent securities in a particular market index and holds them based on their representation within the index.

Since index funds take a passive investment approach, they have significantly lower annual management fees than mutual funds.

How To Buy Index Funds in Canada

You can purchase index funds in Canada through most Canadian brokerage platforms that offer index fund, stock and ETF trading. My top choices are Wealthsimple Trade and Questrade.

To learn more, check out my full breakdown of the best trading platforms in Canada here.

Conclusion

Finding and investing in the best index funds in Canada can provide your portfolio with considerable returns if you are a new investor with a medium to low-risk tolerance, have the investment capital, prefer a passive investing style, and plan to buy and hold the assets in your portfolio for the long run.

There are certain drawbacks of investing in index funds that might not make them a suitable investment for you to consider for your portfolio based on your financial goals.

Suppose that you are interested in creating a portfolio of low-cost financial instruments that can provide you with a decent monthly income. In that case, choosing dividend ETFs might be more suitable for you than putting your money in an index fund.

You should check out my list of the best monthly dividend ETFs in Canada if you want to earn regular passive income.

2. Index funds often outperform actively managed funds

A lot of research (like this report) found only a small percentage of active fund managers outperform index funds. These are professionally managed funds with resources and access to information, yet they still fail to beat the markets on a long term and consistent basis.

What does this mean for you, or any individual DIY investor?

Unless you’re extremely lucky, you probably won’t be able to consistently beat market returns either.

However, with an index investing strategy, over a long period of time, you can expect an average yearly return of about 7% before fees and tax. Remember, fees and taxes are kept at a minimum with index investing.

This 7% figure is an industry benchmark that comes from the historical average return of the S&P since inception and adjusted for inflation. So it’s not out of your personal reach.

3. Index investing is a simple strategy to implement

Index investing requires minimal time and research compared to other strategies. You’ll still have to do some research to figure out what ETFs to buy and how to allocate each of them in your portfolio.

But fear not, you won’t have to study balance sheets and P/E ratios, or the perfect timing to enter and exit positions.

The amount of trading with passive strategy is also limited, so it shouldn’t take too much of your time to keep your investments in check.

The most difficult part of index investing might actually be not letting your emotions rule your behaviour and strong discipline. When there are market swings, stick with your long-term strategy. Remember, historically, the markets have always trended upwards.

4. Index investing offers easy broad diversification

Indices are a great way to limit unsystematic risk. Unsystematic risk is the risk associated with a particular company or industry. If you combine indices together to make a portfolio, then you can diversify most of your risk by choosing indices that represent various industries in various geographical markets.

How to start investing in index funds in Canada

First, build your portfolio with an allocation that works for you. Choose a combination of ETFs that represent indices that follow a large part of the markets. You can also choose your level of risk/expected return by combining stock ETFs and bond ETFs. Generally, stocks expose you to more risk but have better returns than bonds.

When comparing ETFs that track the same index, pay attention to:

• Tracking errors – the divergence between the price behaviour of your portfolio and its benchmark
• MER – Management Expense Ratio – how expensive the fund is for you
• Level of asset – how reliably their fair market value can be calculated
• Trading activity – monitor the buying and selling behaviour

Together, these four components will give you an idea of the ETF liquidity. ETF liquidity is the ease of which an asset can be turned into cash without affecting its market value.

To monitor these factors, use tools such as ETF Database to find and compare ETFs. You can also search for popular ETF model portfolios to help you come up with your portfolio’s asset allocation.

Start index investing to build your long term wealth

Once you figure out what you want to invest in, open a brokerage account at an online discount brokerage and start building your portfolio.

Use your maximum contribution in registered accounts such as RRSP, TFSA and RESP before you start investing in non-registered accounts. You don’t pay taxes on profit and dividends in registered accounts, so that is a good way to make your investments more tax efficient.

To build long-term wealth, the most important thing you can do is contribute early and contribute regularly to benefit from compounding interests. For example, by contributing $5, a year (and reinvesting the interest) over 40 years, you could retire with over a million dollars.*

^{*Assuming a 7% return on investment (average S&P return since inception, adjusted for inflation) and an average blended MER of % (Canadian Couch Potato portfolio).}

The bottom line

Are you ready to start building wealth with index investing? Build an ETF portfolio that diversifies your market exposure, start investing at a discount brokerage, and contribute regularly to take advantage of compounding interest over time.

This article is a guest contribution from Brendan Lee Young of Passiv. Passiv is portfolio management software that makes DIY investing easier. It integrates with your brokerage account and you automate your portfolio management. With Passiv users can invest and rebalance their portfolios in one-click.

An index fund is an investment fund that replicates the composition, performance and risk of a stock index. The S&P/TSX 60, which includes major Canadian companies, and the Dow Jones, which includes the 30 biggest industrial companies in the United States, are two examples of indexes.

The performance of exchange traded funds (ETFs) is generally assessed over the longer term. They require a relatively small minimum investment and offer a fairly low management fee compared to an actively traded investment fund or a portfolio manager who works directly for you. They are part of an overall investment strategy to diversify your investments and protect you from interest rate fluctuations.

The returns, however, can be difficult to predict. These funds require discipline against selling quickly when there are losses because they will likely recover and grow in the long term. You also have to realize that there are no guarantees when it comes to investing and, depending on which funds you choose, the risk may be higher.

Do you have the right investor profile?

These funds follow the performance of the market. Because they fluctuate daily, they might not be the best investment product if you need a steady, guaranteed income. If your tolerance for loss is low, index funds shouldn’t represent your entire portfolio. In general, it’s not a good idea to put all your eggs in one basket when investing your money.

Based on your financial situation and goals, decide what percentage of your total investments these funds should represent to strike a balance that works for you. You can even purchase a group of index funds that corresponds to your profile and risk tolerance.

Patience and discipline are two essential qualities to have when you decide to invest in index funds and you should resist making hasty transactions. You might suffer some losses that you can recover from in a year or even over the course of a decade. That said, the variety of securities held in these funds, combined with their low cost, can yield average returns that are quite respectable. Even Warren Buffett, the famous American investor, recommends investment funds for the larger returns they yield over the long term.

Which index funds are right for you?

Index funds have an interesting advantage. According to Daniel Straus, a National Bank ETF specialist, they are the fastest way to a diversified portfolio. For instance, you can choose funds based on geography (Canadian, American or international funds) or industry (mining or technology).

There are so many index funds out there, it would be impossible to list them all. Some of the biggest are the S&P  and the Dow Jones for American funds, the S&P/TSX for Canadian funds and the MSCI for international funds.

There are funds based on emerging markets and new industries. These can be attractive because their management fees are generally lower than established funds. They can give you larger returns, but they also carry higher risk. This is especially the true with some technology indexes.

Some funds are copies of other funds, with just a few small differences, such as the FTSE, which takes its cues from the MSCI. In both cases, they focus on emerging markets, and the FTSE includes countries that are overlooked by the MSCI.

What makes up an index fund?

A fund includes several securities (Apple, Google, etc.). Each security has a different weight in the fund that is directly related to the percentage of the fund composition that it represents. These weights are limited to reduce the impact of a decline in value of a particular security on the overall return of the fund. Regulations have been established to help avoid crises like the one that happened to Nortel when the tech bubble burst. If the weight of a single security is too high, the impact of the loss is greater.

How do you invest in index funds?

It’s important to have basic knowledge about the market before investing in these funds. It’s equally important to know what you’re buying and to understand the composition of the indexes that interest you to make sure they correspond with your financial goals.

If you’re a seasoned investor, investing in index funds won’t give you any surprises. You can buy them directly on brokerage sites to build your long-term investment strategy or take advantage of short-term forecasts in a particular index. If you already have one of these accounts, you’re good to go.

Whether you’re new to investing or an old hand, it’s a good idea to speak with an expert to determine your investor profile and your needs. Together, you can develop an investment plan to help you reach your financial goals. There are many types of funds—you just have to find the one that’s right for you.

2. Index funds often outperform actively managed funds

A lot of research (like this report) found only a small percentage of active fund managers outperform index funds. These are professionally managed funds with resources and access to information, yet they still fail to beat the markets on a long term and consistent basis.

What does this mean for you, or any individual DIY investor?

Unless you’re extremely lucky, you probably won’t be able to consistently beat market returns either.

However, with an index investing strategy, over a long period of time, you can expect an average yearly return of about 7% before fees and tax. Remember, fees and taxes are kept at a minimum with index investing.

This 7% figure is an industry benchmark that comes from the historical average return of the S&P since inception and adjusted for inflation. So it’s not out of your personal reach.

3. Index investing is a simple strategy to implement

Index investing requires minimal time and research compared to other strategies. You’ll still have to do some research to figure out what ETFs to buy and how to allocate each of them in your portfolio.

But fear not, you won’t have to study balance sheets and P/E ratios, or the perfect timing to enter and exit positions.

The amount of trading with passive strategy is also limited, so it shouldn’t take too much of your time to keep your investments in check.

The most difficult part of index investing might actually be not letting your emotions rule your behaviour and strong discipline. When there are market swings, stick with your long-term strategy. Remember, historically, the markets have always trended upwards.

4. Index investing offers easy broad diversification

Indices are a great way to limit unsystematic risk. Unsystematic risk is the risk associated with a particular company or industry. If you combine indices together to make a portfolio, then you can diversify most of your risk by choosing indices that represent various industries in various geographical markets.

How to start investing in index funds in Canada

First, build your portfolio with an allocation that works for you. Choose a combination of ETFs that represent indices that follow a large part of the markets. You can also choose your level of risk/expected return by combining stock ETFs and bond ETFs. Generally, stocks expose you to more risk but have better returns than bonds.

When comparing ETFs that track the same index, pay attention to:

• Tracking errors – the divergence between the price behaviour of your portfolio and its benchmark
• MER – Management Expense Ratio – how expensive the fund is for you
• Level of asset – how reliably their fair market value can be calculated
• Trading activity – monitor the buying and selling behaviour

Together, these four components will give you an idea of the ETF liquidity. ETF liquidity is the ease of which an asset can be turned into cash without affecting its market value.

To monitor these factors, use tools such as ETF Database to find and compare ETFs. You can also search for popular ETF model portfolios to help you come up with your portfolio’s asset allocation.

Start index investing to build your long term wealth

Once you figure out what you want to invest in, open a brokerage account at an online discount brokerage and start building your portfolio.

Use your maximum contribution in registered accounts such as RRSP, TFSA and RESP before you start investing in non-registered accounts. You don’t pay taxes on profit and dividends in registered accounts, so that is a good way to make your investments more tax efficient.

To build long-term wealth, the most important thing you can do is contribute early and contribute regularly to benefit from compounding interests. For example, by contributing $5, a year (and reinvesting the interest) over 40 years, you could retire with over a million dollars.*

^{*Assuming a 7% return on investment (average S&P return since inception, adjusted for inflation) and an average blended MER of % (Canadian Couch Potato portfolio).}

The bottom line

Are you ready to start building wealth with index investing? Build an ETF portfolio that diversifies your market exposure, start investing at a discount brokerage, and contribute regularly to take advantage of compounding interest over time.

This article is a guest contribution from Brendan Lee Young of Passiv. Passiv is portfolio management software that makes DIY investing easier. It integrates with your brokerage account and you automate your portfolio management. With Passiv users can invest and rebalance their portfolios in one-click.

An index fund is an investment fund that replicates the composition, performance and risk of a stock index. The S&P/TSX 60, which includes major Canadian companies, and the Dow Jones, which includes the 30 biggest industrial companies in the United States, are two examples of indexes.

The performance of exchange traded funds (ETFs) is generally assessed over the longer term. They require a relatively small minimum investment and offer a fairly low management fee compared to an actively traded investment fund or a portfolio manager who works directly for you. They are part of an overall investment strategy to diversify your investments and protect you from interest rate fluctuations.

The returns, however, can be difficult to predict. These funds require discipline against selling quickly when there are losses because they will likely recover and grow in the long term. You also have to realize that there are no guarantees when it comes to investing and, depending on which funds you choose, the risk may be higher.

Do you have the right investor profile?

These funds follow the performance of the market. Because they fluctuate daily, they might not be the best investment product if you need a steady, guaranteed income. If your tolerance for loss is low, index funds shouldn’t represent your entire portfolio. In general, it’s not a good idea to put all your eggs in one basket when investing your money.

Based on your financial situation and goals, decide what percentage of your total investments these funds should represent to strike a balance that works for you. You can even purchase a group of index funds that corresponds to your profile and risk tolerance.

Patience and discipline are two essential qualities to have when you decide to invest in index funds and you should resist making hasty transactions. You might suffer some losses that you can recover from in a year or even over the course of a decade. That said, the variety of securities held in these funds, combined with their low cost, can yield average returns that are quite respectable. Even Warren Buffett, the famous American investor, recommends investment funds for the larger returns they yield over the long term.

Which index funds are right for you?

Index funds have an interesting advantage. According to Daniel Straus, a National Bank ETF specialist, they are the fastest way to a diversified portfolio. For instance, you can choose funds based on geography (Canadian, American or international funds) or industry (mining or technology).

There are so many index funds out there, it would be impossible to list them all. Some of the biggest are the S&P  and the Dow Jones for American funds, the S&P/TSX for Canadian funds and the MSCI for international funds.

There are funds based on emerging markets and new industries. These can be attractive because their management fees are generally lower than established funds. They can give you larger returns, but they also carry higher risk. This is especially the true with some technology indexes.

Some funds are copies of other funds, with just a few small differences, such as the FTSE, which takes its cues from the MSCI. In both cases, they focus on emerging markets, and the FTSE includes countries that are overlooked by the MSCI.

What makes up an index fund?

A fund includes several securities (Apple, Google, etc.). Each security has a different weight in the fund that is directly related to the percentage of the fund composition that it represents. These weights are limited to reduce the impact of a decline in value of a particular security on the overall return of the fund. Regulations have been established to help avoid crises like the one that happened to Nortel when the tech bubble burst. If the weight of a single security is too high, the impact of the loss is greater.

How do you invest in index funds?

It’s important to have basic knowledge about the market before investing in these funds. It’s equally important to know what you’re buying and to understand the composition of the indexes that interest you to make sure they correspond with your financial goals.

If you’re a seasoned investor, investing in index funds won’t give you any surprises. You can buy them directly on brokerage sites to build your long-term investment strategy or take advantage of short-term forecasts in a particular index. If you already have one of these accounts, you’re good to go.

Whether you’re new to investing or an old hand, it’s a good idea to speak with an expert to determine your investor profile and your needs. Together, you can develop an investment plan to help you reach your financial goals. There are many types of funds—you just have to find the one that’s right for you.