Introduction to Exchange Traded Funds

Submitted by Sharemarket News on 1 July, 2011 - 17:12

Everything about Exchange Traded Funds (ETFs).

Investors spend hours of their time deciding which stock to buy. Everybody wants to profit, and stocks giving good returns are the target. As opposed to trading individual stocks, trading ETFs (Exchange Traded Fund) allows you to invest in a wide range of shares and gives you a gestalt picture of the Australian sharemarket. Think of ETFs as trading the market in one trade.

Some investors don't want the hassle of going through stock selection, so they invest in managed funds. A managed fund allows you to pool your capital along with other people's money. The person who manages the fund then invests this pot of money as a whole depending the fund's objectives. ETFs offer investors exposure to local and international markets, not only to the Australian market and it sectors.

An exchange-traded fund is a type of managed fund, but it trades like a share. This fund is a diversified portfolio of securities that tracks or follows an index. How does tracking work? Say your ETF is over the S&P/ASX200 Index. Percentage movements in the index is followed by the percentage changes in the ETF price.

Like shares, you trade ETFs on the ASX through your broker.

Why Buy ETFs?

So what are the advantages of buying ETFs as opposed to stocks alone? When your money is spread across a range of shares, risk is decreased. A crash will not have as much of an impact on your portfolio as when your shares are only from one or two companies.

ETFs also offer diversification to your investment portfolio. As mentioned, ETFs follow an index, which is a compendium of several hundred stocks. This means that you get exposed to the same number of stocks that the ETF is tracking while paying brokerage for only one transaction.

ETF earnings are through income and capital. The ETF fund receives dividends that gets passed on to your portion of the fund, and if the market performs well, your ETF value will also increase. A downturn on the other hand, will decrease the ETF value.

ETFs are passively managed funds, which means that the fund managers follow predetermined guidelines for their particular funds. ETFs generally offer bigger tax benefits than standard mutual funds, and due to the low securities turnover, ETFs realise and get fewer capital gains than actively managed funds.

ETF investors can always see what they are buying into, since ETFs replicate the performance of their underlying index. Fees and details are clearly laid out, as opposed to mutual funds which report their holdings only twice yearly.

ETFs have lower annual fees compared to mutual funds because of decreased marketing and accounting expenses and the passive nature of index investing. Investors do have to pay brokerage commission to buy and sell ETF shares. The brokerage fees can significantly multiply, however, for investors who trade very high volumes.

Options that are included in most ETFs can also be traded. Options allow you to create varied investment strategies and use leverage.

Download our FREE App


Signup for Free
Don't miss out on your free share trading articles.


Free Risk Money Management Calculator for those who sign up!