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A very quick and simple introduction to an asset class which has seen exponential growth in the last few years – Exchange Traded Funds, or ETFs for short.
With a total global market cap in excess of $7 trillion – ETFs have definitely become a mainstream asset class.
Watch the video here:
Today’s video is going to be a very quick and simple introduction to an asset class which has seen exponential growth in the last few years, and that is on exchange traded funds, or ETFs for short.
With a total market global market cap in excess of $7 trillion – ETFs have definitely become a mainstream asset class.
But first, what is an ETF?
Well an ETF is a collection of investments that trade just like a stock on an exchange, and is generally used to track the performance of a specific market index.
Being exchange traded, ETFs are bought and sold just like any share on a stock exchange.
E.g. If you want to invest in the overall ASX 200 Index, you can buy an ETF that will mimic its movements. You can also buy ETFs that track other benchmark indices such as the S&P 500, the NASDAQ 100, or other indices like Gold and Oil.
How Does It Work?
In simple terms, an ETF provider first considers a universe of assets, such as stocks, bonds, commodities or currencies, and creates a basket of them, with a unique code.
Investors can then buy a share of that basket on an exchange, just like buying shares of a company.
Buyers and sellers can then trade the ETF throughout the day, just like with stocks.
ETFs are available for a range of asset classes and individual assets including:
Australian and International shares, or individual sectors of the Australian and international share market such as financials or real estate. They can also include broader sectors like bonds, precious metals, commodities and foreign currencies.
1) Diversification – ETFs allow you to buy a basket of shares or assets in a single trade. This can help to diversify within an asset class. Additionally, they allow you access to markets or sectors which can be difficult or expensive to access.
2) Transparency – ETF providers publish their net asset value (NAV) daily . The NAV is the market value of the ETF’s assets after fees, interest, and other expenses are deducted. This allows you to continually track how the underlying assets are performing.
3) Low cost – a lot of ETFs have low management fees, e.g one of the lowest is the iSHARES CORE SP/ASX 200 ETF has a management fee of just 0.09%.
And what about the main cons?
1) Market or sector risk – while ETFs allows diversification, the market or sector the ETF is tracking could fall in value.
2) Currency risk – if the ETF invests in overseas assets, such as in the US – you face the risk of currency movements impacting your returns, although some are currency-hedged, which means the currency fluctuations are mitigated.
3) Liquidity risk – some ETFs invest in asset that are not liquid, such as those in emerging markets. This can make it difficult at times for the ETF provider to create or redeem securities.
So what Should You Invest In?
This all comes down to your level of comfort and risk tolerance, but here in Australia, there’s over 200 main ETFs to choose from across a range of market sectors, but which one do you pick?
With so much choice, personally I tend to stick to the big players, and you could do a lot worse than choosing from the big 3 providers of iSHARES, Vanguard and State Street SPDR.
But for those of you who are keen, check out this link for a fairly comprehensive ETF market index of over 200 for you to choose from.
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