What is an ETF?
An Exchange-Traded Fund (ETF) is a managed fund that can be sold and bought on a listed exchange, much like how you would buy shares.
ETFs are an easy and low-cost way to earn a return and diversify your investments. You are able to sell units in ETFs through a stockbroker.
How ETFs work?
In Australia, ETFs are commonly ‘passive’ investments, which means they do not try to outperform the market. The function of the fund manager is to track the value of:
- An index e.g. the ASX200 or S&P500
- A specific commodity, such as gold
The value of the ETF can go up or down with their index or asset that is being tracked.
Types of ETFs
ETFs can be physically-backed or synthetic.
Physically-backed ETF - A physical ETF tracks the target index. This is done by holding all, or some, of the underlying assets of the index.
Synthetic ETF - Instead of investing money in physical stock shares, synthetics ETFs invest in stocks and derivatives.
Pros and Cons of ETFs
Before you decide to invest in ETFs, it's important to think about the pros and cons.
You can buy a basket of shares or assets in one individual trade, which can help diversify your investment within an asset class. ETFs also let you invest in markets or assets that are hard or expensive to access. When you diversify your ETFs, there is a smaller likelihood of loss if an ETF provider collapses.
ETFs are reasonably transparent as they publish the net asset value (NAV) every day on the ASX. Using the NAV will allow you to track how the underlying asset is performing and if the ETF price is close to the NAV.
Many ETFs have a low management expense ratio (MER). They are commonly cheaper in comparison to most actively managed funds.
You can easily buy and sell ETFs during trade hours of the exchange.
Market or sector risk
While ETFs can help you diversify, the market or sector the ETF is tracking could fall in value. For example, if the ASX200 declines, the value of your ETF investment will also fall.
If the ETF invests in assets that are international, there is a risk of currency movements, which can affect your returns. However, some ETFs are 'currency hedged' which reduces this risk factor.
There are some ETFs that invest in assets that are not liquid, such as emerging market debt. In these cases, it can be more difficult at times for the ETF provider to create or redeem securities.
It is possible for an ETF’s price to stray away from the value of the index or asset it is designed to track. The reason for this can be due to the illiquidity of the underlying assets, fees, taxes and other factors. This means when you buy or sell, your ETF could be trading not at the net asset value.
For financial advice on ETFs, contact Wagtail Wealth today.
IMPORTANT NOTE: This information is general advice only and does not take into account your personal circumstances, goals and objectives. Therefore, you should consider its appropriateness for your circumstances before acting on this information.