Everyone seems to be talking about ETFs right now, so here’s the lowdown on why Exchange Traded Funds are so damn interesting.
While they can date their origins back to the 1990s, exchange traded funds (ETFs) truly took off this century. Their popularity is largely based on the ease with which they give investors access to parts of the investment market that would otherwise be inaccessible to them.
So, what exactly is an ETF?
ETFs are essentially managed funds made up of multiple securities or other assets. However unlike traditional managed funds, they are listed on a stock exchange, making them easy to buy into and sell out of.
There are more than 200 ETFs listed on the Australian Stock Exchange (ASX).
There are four general types of ETFs listed. They track:
- an index (like the ASX200)
- a single asset class (such as gold)
- a sector (such as property, energy or sustainable investments)
- an investment outcome (such as yield)
In order to understand how closely the ETF is tracking the underlying assets or index it is based on, ETFs publish their net asset value daily on the stock exchange.
How do you buy ETFs?
You can’t actually buy individual exchange traded funds. Instead you buy units in an ETF, similar to the way you’d buy shares in a company or units in a managed fund.
As with more traditional shares, ETFs can be bought through a stockbroker or an online trading platform. And like traditional stock exchange-traded shares, the minimum investment in an ETF that trades on the ASX is $500.
What are the advantages of ETFs?
ETFs are popular mainly because they can give you diversification at a low cost. For example, in one $500 investment you could buy into an ETF that invests in everything from Australian shares, global shares, fixed income, debt and foreign currencies to commodities and metals.
The fact that they are easy to buy and sell, with minimal transaction costs, also adds to their popularity. As does the daily publication of the net asset value, which makes ETF pricing more transparent than some other types of investments.
What are the disadvantages of ETFs?
While their diversification tends to offset some risk, the level of risk you face in holding an ETF will depend on how diversified the ETF you’re invested in is. For example, if you invest in an ETF with quite narrow diversification, such as an ETF that tracks gold, and the gold price falls, your investment will also experience a fall.
Similarly, if the ETF you’re invested in has a large overseas exposure you could be subject to some currency risk. Or if you’re invested in a less popular ETF, there could be some liquidity risk in terms of the timing of when you can sell your investment.
Another potential disadvantage is the possibility that the price of an ETF unit could move away from the index or asset it is designed to track. So it’s important to be aware of this when you’re buying or selling an EFT.
Exchange traded funds might also not be the best investment for someone who prefers a more hands-on approach or likes to actively manage their investments. You don’t have any say in exactly which assets the ETF is invested in or in what volumes.
Check the fees and read the fine print
ETF issuers also charge a management fee, which is reflected in the daily price of the ETF.
As with any investment, you should do your research to make sure you’re fully aware of how ETFs work and determine whether they are the right type of investment for you.