ETFs or Exchange Traded Funds let you invest in a range of stocks, bonds, commodities or other assets in a single package. ETFs often track a specific market, sector or index, like FTSE100 or S&P 500.
What are ETFs?
Investors can trade ETFs throughout the trading day on a stock exchange. ETFs are structured in various ways and come in different types. Many ETFs track a single stock or market, whereas others can track large and diverse collections of assets and securities.
ETFs, let you invest in multiple assets without buying each asset individually, making it less risky with lower fees than other funds.
Before we dive in, it’s essential to know the difference between an ETF and an Index fund. An index fund is a portfolio of assets designed to mimic the financial market index, whereas an Exchange Traded Fund is a collection of securities traded on an exchange.
How are ETFs traded?
Fund managers create ETFs to track the performance of a group of assets. Similarly to stocks, ETFs are then sold as shares in that particular fund.
It’s important to note that the investors don’t have any rights to the underlying assets. Instead, they own a portion of that Exchange Traded Fund that tracks the underlying assets’ value.
In simple terms, here’s how ETFs are made and traded:
- A fund manager will analyse the market and create a set of stocks, bonds, commodities and/or other assets.
- A fund manager will give this set a unique identifier known as the ticker.
- Investors will find this set using the ticker and buy/sell shares of this set throughout the day on the exchange market.
Type and variations of ETFs
Just like any investments, ETFs come in different types and variations. Each ETF type comes with its own set of pros and cons, costs, commission fees and risks.
- Stocks ETFs: invest in single equity or a group of stocks, usually meant for long-term investment.
- Sector & Industry ETFs: sector ETFs focus on investing in a specific market sector or industry, for example, technology or healthcare.
- Commodity ETFs: commodities are raw goods such as gold, crude oil and sugar. Commodity ETFs mix these securities into a single investment.
- Bond ETFs: focus on fixed-income securities such as corporate bonds or treasuries.
- Currency ETFs: invest in foreign exchange markets (forex).
- International / Foreign market ETFs: focus on international investments only but can focus on a global scale, individual country or region.
- Alternative investment ETFs: invest in innovative markets and strategies, allowing investors to trade on volatility or use a specific trading strategy.
- Style ETFs: focus on the style (value & growth) and/or asset class (small-cap, mid-cap, large-cap).
- Inverse or short ETFs: focus on profiting from the decline in the value of the asset. Similar to shorting multiple positions.
- Leveraged ETFs: focus on financial derivatives to amplify the return of an underlying asset. While a typical ETF tracks the asset’s price on a 1:1 basis, leveraged ETFs can go as high as the 3:1 ratio.
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Are ETFs safe?
ETFs are a reasonably safe type of investment because the majority of the ETFs are indexed funds. These buy the same assets as the given index, for example, FTSE100 and attempt to replicate the return.
However, the risk is increased depending on the type of ETF you trade. For example, leveraged ETFs are considered the riskiest as they use debt (they borrow money) to increase the exposure. Hence, there is a greater chance to lose your investment or increase your returns.
How to get started with ETFs?
Getting started with ETFs is easy; follow these steps:
- Find an ETF you want to invest in
- Find a reputable online broker with low fees to buy ETFs such as Vanguard.
- Make sure you understand the trading terms and conditions
- Sign up with the online broker and invest in ETF
Alternatively, if you’re more of a hands-off trader, you can use a robo-advisor such as Unhedged to invest in ETFs.
Robo-advisors construct their portfolios using AI and Machine Learning without emotional interruption, giving them the advantage over manual traders.
How to choose an ETF?
Generally, ETFs come with lower fees compared to other investments. However, costs can vary between the brokers and funds. Here’s our advice on how to choose an ETF to invest in:
- The total value of assets: an ETF should have a minimum value in assets under management. If it’s low, there can be liquidity issues, and the ETF can trade with a hefty price spread (spread is the difference between the buy price and the selling price).
- Charges: ETFs usually have low fees but will vary from ETF to ETF, so make sure you do your research. Sometimes you will find a few ETFs with similar exposure but with different charges (VOO vs SPY)
- Trading volume: higher trading volume usually indicates a more stable ETF.
- Performance over time: although past performance is not a direct indicator, it can give you an idea of how an ETF was performing over time and guide your decision.
As with any investments, ETFs can be very profitable. However, before you run and deposit your savings, do your due diligence, research the market, understand all the risks, and choose the ETF that suits you and your goals.
If you prefer the hands-off approach, start with a Robo-advisor such as Unhedged. Robo-advisors research for you and invest using artificial intelligence to maximise the returns without any emotional attachment.
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Disclaimer: The information in this article is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.