What the hell is an ETF anyway? and what are the potential benefits and cons of ETF’s.
ETF’s or Exchange Traded Funds are managed funds that you can buy in or sell just like an individual share on the ASX or Australian Securities Exchange (or if you are in another country your own country/regions share exchange).
There are many different types of ETF’s so its important that you do your research into a potential ETF before taking the plunge and investing any of your hard earned funds.
If you’ve heard of ETF’s on the #debtfree or #fire community then you would likely have heard of people (like me) in these communities investing in ETF’s.
What is the difference between ETF’s and Individual Shares?
ETF’s differ from individual shares in that you don’t own the underlying assets/or shares held within the ETF. You own the units within the ETF and the ETF provider (eg Vanguard a well known ETF provider owns the investment itself).
ETF’s differ as well in regards to individual shares in that they typically give you exposure to more than one company, sector, asset, or market. Dependant on what ETF you select this spreads your risk exposure to more than one company, and offers diversification to reduce your risk in the event of a company failing or a market event.
What kind of ETF’s are out there?
As of March 2020 there were 200 ASX listed ETF’s and this list is always growing. Additionally ETF’s are becoming more diverse in terms of what they invest in as demand for ETF’s grows. The list I’ve complied below lists some of the different markets, sectors and other assets that ETF’s invest in:
- Australian Shares
- International Shares
- Sustainable/Ethical Shares
- Sector based share holdings (eg banking, technology, healthcare or mining)
- Bonds (eg fixed income investments)
- Gold or other metals
- and there are many others.
I hope you can see from the list above its important to know exactly what your ETF invests in before you invest in it yourself. Its important to align your values and risk profile with a ETF that meets your needs.
Benefits of ETF Investment
- Diversification – This is the big one for me. You can purchase a number of shares in a single trade within single or multiple markets (eg Australia and International Shares). You can also select ETF’s that are diversified across multiple markets/asset classes to spread your risk even further. You can also select ETF’s that aim to provide fixed income or monthly distributions. Don’t skimp on your research.
- Access to Markets – Investing in individual shares in overseas markets can be difficult for Australian’s so an ETF may be an easier option if let say you wanted to invest in the Indian Share Market.
- Low Cost – ETF’s are usually cheaper than an actively managed fund. If you do want to know more about actively managed funds use this link here. You can find out the cost of the ETF by checking the management expense ratio or MER (%). You can find this information when you are researching your ETF (if you can’t find the MER referred to directly your ETF may also call it their yearly fees).
- Trade like a Share – ETF’s can be traded just like a share, and just like buying an individual share you buy during the trading hours of the exchange.
- Income (known as Distributions) – ETF’s just like shares may also offer regular distributions monthly, quarterly, semi yearly, or yearly. Many ETF’s also offer Distribution Reinvestment Plans (see article here to learn more) , which may be something on your list of wants for your future investment.
- Higher Liquidity over Property – Just like a typical Share Holding when you sell an ETF you should expect to receive your funds within 2 business days of the close of market. This means that ETF’s offer better liquidity than an investment property for example.
Cons or Risks
- Investment Risk – The biggest con of all of ETF’s is market risk (same as buying shares). Buying a diversified ETF doesn’t shield you from market risk. The investments your ETF invest in could still fall in value, and anyone who owned ETF’s during Covid-19 (or any other crash) would agree. However if you view any ETF investment as long term you will also know that the market has since rebounded, and no money was lost unless you sold out your holdings. Buy and hold forever is my strategy for investing so I don’t worry about what is happening to the market day to day.
- Choice – As previously mentioned you need to do your research before buying ETF’s. There is a lot of choice out there, and you need to do your due diligence (just like investing in anything). Two ETF’s may both invest in the Technology Sector, but there may be important differences between the two. Make a shortlist of ETF’s, research the ETF provider to ensure they are reputable, and know what your ETF holdings are made up of.
- Tax – If you are used to investing in individual shares you will likely know how your tax is calculated. Dependant on your ETF holding you may find that doing your tax for an ETF is quite different to owning individual shares. Your end of year ETF statement provided by Computershare (link to article) includes distributions rather than typical dividend income, foreign income, and capital gains even though you didn’t physically sell any ETF’s. Make sure you know your tax responsibilities in regards to any ETF’s you purchase, and consider seeking professional taxation advice.
Why I invest in ETF’s
I’m 100% a passive investor therefore ETF’s suit me well. I don’t like to actively manage my shareholdings or sell shares to rebalance my portfolio. Instead I take a set and forget approach and aim to buy and never sell. I’m 100% a passive investor therefore ETF’s suit me well.
Please note: This is not advice this is what I have researched and what I feel comfortable investing in. I evaluate my investments regularly and my investments and risk profile may change over time.
If you would like to know more about what ETF’s are available I have listed some ETF providers below (Australian Links):
- Vanguard – Home | Vanguard Australia Personal Investor
- BetaShares – BetaShares Exchange Traded Funds | ETF Australia
- iShares – Exchange-Traded Funds (ETFs) | iShares CH – BlackRock
- ETF Securities – ETF Securities Australia | ETFs | Exchange Traded Funds
- VanEck – VanEck Australia
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