Most explanations of the stock market share one flaw: they start in the middle of the story. You are told about the S&P 500 before anyone has told you what an index is. ETFs are recommended to you before anyone has explained what they contain.
The result: many people invest, sometimes for years, without really understanding what they own. I know something about that. For quite a while, I nodded along when people talked about indexes, when I could not have clearly explained the difference between a stock, an index and an ETF.
So this article picks the story up from the very beginning, assuming no prior knowledge. By the end, you will know not only what a stock index is, but above all how to use that knowledge to choose an investment intelligently.
Step 1: in the beginning, there were stocks
A stock is a share of ownership in a company. Buying a share of Apple means owning a tiny piece of Apple. If the company gains value, so does your share. If it declines, so does your share.
For a long time, investing meant exactly that: choosing companies one by one. With $1,000, you had to decide — Apple, Coca-Cola or Bell Canada? The limit of that approach is obvious: you are betting on a single company. One bad pick can be very costly, and even professional managers get this wrong on a regular basis.
Step 2: someone invents a list
Investors eventually asked a simple question: how do you know whether the American market is doing well as a whole, without examining hundreds of companies one by one? The answer was to create a list. That is exactly what a stock index is: a list of companies, along with a calculation that tracks their combined value day after day.
The S&P 500, for example, is the list of the 500 largest American companies. When you hear that the S&P 500 gained 1 % today, it means that, taken together, those 500 companies are worth 1 % more than the day before.
"An index is a list with a calculation. You cannot buy it. It is a thermometer, not an investment. The thermometer tells you the temperature; it does not heat the room."
Step 3: the problem, then the invention that changed everything
Naturally, investors wanted to own the companies on the list. But buying 500 different stocks, one at a time, is practically impossible for an individual: it would take considerable capital and an enormous amount of management time.
This is where investment firms like Vanguard and BlackRock had the idea that democratized the stock market: buy the 500 companies themselves, pool everything into one large fund, then divide that fund into millions of small shares accessible to everyone. Those shares are ETFs (exchange-traded funds).
The full thread comes down to this:
- Stocks exist (Apple, Microsoft, and so on)
- Someone creates a list of those stocks and tracks its value: that is the index
- A firm actually buys every stock on the list and pools them into a fund
- That fund is divided into shares you can buy in your brokerage account: that is the ETF
When someone says they bought the S&P 500, it is a figure of speech. What they actually bought is a share of an ETF that holds the 500 companies on the list.
An ETF works like a photocopier. The index says Apple is 7 % of the list, and the ETF replicates that proportion. The index drops a company? The ETF drops it too. The investor has nothing to manage: the copying happens automatically.
An important clarification: this is not "interest"
Before going further, a point of vocabulary that prevents a lot of confusion. An ETF does not pay an interest rate like a savings account. Money is made in two ways:
- Growth: the value of the shares rises when the companies on the list gain value. That gain only materializes when you sell.
- Dividends: some companies distribute part of their profits to shareholders, and the ETF passes those amounts on to unit holders, generally monthly or quarterly.
Some indexes mostly group growth companies, which reinvest their profits; others mostly dividend companies, which distribute them. That distinction becomes decisive when it comes time to choose, and it is the whole point of our article on dividends versus pure growth. So we speak of return, never of guaranteed interest: some years are positive, others negative.
The ten major indexes worth knowing
There are tens of thousands of indexes in the world. In practice, about ten are enough to understand the essentials, and three or four are enough to build a complete portfolio.
The returns shown below are approximate historical annualized averages, over long periods, with dividends reinvested, before fees and inflation. They vary with the period measured and guarantee absolutely nothing for the future.
| Index | What it groups | Dominant profile | Historical average annual return | Well-known ETFs tracking it |
|---|---|---|---|---|
| S&P 500 | The 500 largest American companies | Growth, with a dividend component | about 10 % | VOO, IVV, SPY, XUS.TO, VFV.TO |
| Nasdaq-100 | The 100 largest non-financial companies on the Nasdaq, heavily concentrated in technology | Strong growth, strong volatility | about 13 %, with sometimes brutal drops | QQQ, QQC.F |
| Dow Jones | 30 large, established American companies | Balanced, mature companies | about 8 to 10 % | DIA |
| Russell 2000 | 2,000 small American companies | Riskier growth | about 8 to 9 % | IWM |
| S&P/TSX Composite | The main Canadian companies: banks, energy, telecoms | Generous dividends, moderate growth | about 7 to 8 % | XIC.TO, VCN.TO |
| S&P/TSX 60 | The 60 largest Canadian companies | Dividends, stability | about 7 to 8 % | XIU.TO |
| MSCI World | About 1,500 large companies from developed countries | Balanced, highly diversified | about 8 to 9 % | XWD.TO |
| FTSE All-World | Thousands of companies worldwide, emerging markets included | Balanced, maximum diversification | about 8 % | VT, and the logic behind XEQT and VEQT |
| STOXX Europe 600 | 600 large European companies | Dividends, moderate growth | about 6 to 7 % | Various European ETFs |
| Nikkei 225 | 225 large Japanese companies | Highly variable depending on the period | Historically irregular: difficult decades from 1990 to 2010, strong recovery since | EWJ |
The Canadian market is a dividend market. Our indexes are dominated by banks, pipelines and telecommunications, mature companies that redistribute their profits. That is what explains the abundance of Canadian dividend ETFs.
The Nasdaq-100 is the growth engine. Few dividends, but historically the strongest progression over long periods, at the cost of sometimes severe corrections along the way. In 2022, for example, it fell about 33 % before recovering. It is the highest return in the table, but also the bumpiest ride.
The Nikkei illustrates the other lesson, less often told: a major index can stagnate for decades. Geographic diversification is not a theoretical detail.
How to make an informed choice
This is where information becomes a decision. The reasoning always runs in this order, and never the other way: first the goal, then the index, and only then the ETF.
Many people do the opposite: they hear about an ETF on social media and buy it without knowing which list it replicates. That is buying a house without knowing the neighbourhood.
Step A — The goal determines the profile
- Horizon of 15 to 20 years or more, growth objective: growth indexes (S&P 500, Nasdaq-100) have historically delivered the best long-term returns, in exchange for volatility you must be able to tolerate without panic-selling.
- Need for regular income, or retirement approaching: dividend indexes (TSX 60, Canadian dividend ETFs) pay out regular amounts without your having to sell shares.
- Looking for simplicity and maximum diversification: global indexes (MSCI World, FTSE All-World) spread capital across thousands of companies and dozens of countries in a single investment.
Step B — Find the ETFs that track the chosen index
Suppose the choice falls on the S&P 500. Several firms offer an ETF that replicates it: VOO, IVV, SPY, XUS.TO, VFV.TO. All hold essentially the same 500 companies. How do you tell them apart?
Step C — The five criteria that separate equivalent ETFs
Management fees (MER)
This is the percentage the issuer charges every year. For a given index, it is the most important criterion, because it is the only guaranteed and recurring cost. Between 0.10 % and 0.60 %, the difference looks negligible — the calculation at the end of this article shows that it is not.
Currency and conversion
An ETF listed in Canadian dollars (VFV.TO, XUS.TO, QQC.F) avoids CAD-USD conversion fees on every trade. An ETF listed in USD (VOO) often shows a slightly lower MER, but the conversion eats part of that advantage, especially on small regular amounts. For automatic monthly purchases inside a TFSA, the Canadian version is generally more practical.
Currency hedging
Some Canadian ETFs neutralize fluctuations in the U.S. dollar, others do not. Hedging adds fees and, over a 15- to 20-year horizon, currency fluctuations tend to even out. Personally, over a long horizon, I consider that the fee advantage of an unhedged version offsets the exposure to currency risk.
How dividends are handled
Some ETFs pay dividends in cash, others offer automatic reinvestment. During the accumulation phase, automatic reinvestment maximizes the effect of compounding with no effort and nothing forgotten.
The size and age of the fund
An established ETF, with substantial assets under management, trades with minimal price spreads and carries little risk of being closed by its issuer. Between a $10 billion fund and a $50 million fund launched last year, the first offers extra peace of mind.
A word on the issuer itself: Vanguard, BlackRock (iShares), BMO and Invesco are all solid, regulated players. At equivalent fees and structure, the issuer is rarely the deciding factor — the five criteria above are what make the real difference.
All of this information is public and free: each ETF's official page shows the index tracked, the full list of holdings, the MER, the distribution policy and the return history. Fifteen minutes of reading is enough to compare two funds seriously — less time than people spend comparing two phone plans. Our ETF radar does a good part of that comparison for you.
The calculation that makes all of this concrete
Two investors each put in $10,000, then add $3,000 a year, into an ETF tracking the same index, with the same gross return of 7 % per year. One difference only: the fees.
- Investor A: MER of 0.10 %, so a net return of about 6.9 %
- Investor B: MER of 0.60 %, so a net return of about 6.4 %
After 25 years, A ends up with about $250,000, and B with about $231,000.
"Nineteen thousand dollars of difference. For the same index, the same companies, the same risk. The only variable was half a decimal point of fees that most people never look at."
That is precisely why the order of reasoning matters: the index determines what you own, but the choice of ETF determines what you keep. It is also the whole subject of our article on investment fees.
In summary
A stock is a company. An index is a list of companies with a thermometer attached. An ETF is a real basket, filled by copying the list, divided into shares you can buy inside a TFSA or an RRSP in a few minutes.
The investor's job comes down to three decisions: which profile matches your goal and horizon, which index embodies that profile, and which ETF replicates that index at the best cost. Everything else — selecting the companies, adjusting the weights, replacing the ones that leave the list — happens automatically. That leaves one practical question: how many ETFs do you actually need?
It took me time before the whole picture became clear. If this article spared you that detour, it has done its job.
And if the next step is opening an account to act on it: the step-by-step guide is here.
Informational content only — not official financial advice. I am not a financial planner. The historical returns mentioned are long-term approximations and do not guarantee future returns. Consult a professional for your specific situation.