What’s an ETF?
- ETF stands for exchange-traded fund. It's an investment fund that’s bought and sold on a stock market.
- ETFs offer a way to invest in the overall performance of an index or a collection of assets, rather than one asset.
- These assets could include shares, commodities, or bonds.
Why would you invest in an ETF?
Some investors spend days, if not weeks, deciding whether to buy a stock.
But most people’s goal is to find stocks that will provide good returns, and many people don’t have the time or expertise to pick individual companies.
So instead, some people choose an asset that lets them invest in a whole market, index, or other collection of stocks – an ETF.
How do ETFs work?
ETFs, or exchange-traded funds, are investment funds that are traded on a stock exchange, similar to stocks.
An ETF has underlying assets, which could be stocks, commodities or bonds. And many ETFs will track an index, such as the S&P 500.
What’s an example of an ETF?
The S&P 500 is the 500 largest companies listed on the NYSE or NASDAQ.
An ETF that tracks the S&P 500 is the iShares Core S&P 500 ETF.
This means, by buying into this ETF (or one like it), an investor can gain exposure to 500 companies in one transaction. Before ETFs, they would have to buy at least one share from each company or invest through managed investment schemes to have similar exposure. This would generally come with higher fees than investing in an ETF.
ETFs that track an index are one alternative that can provide diversification, lower transaction costs, and with flexibility, than buying and selling individual stocks.
How to invest in ETFs
1. Research your options
The first step to investing in ETFs is to figure out the type of ETF you want to invest in.
Here are some common ones:
Equity funds: These are generally made up of shares, and track indexes or sectors. Examples of these include the Vanguard MSCI International Shares ETF (VGS) and the Vanguard S&P 500 ETF.
Fixed-income funds: These are generally made up of bonds and bank notes, which produce lower risk, regular income over timeboxed periods. An example of this include the iShares Core Global Corporate Bond (AUD Hedged) ETF (IHCB).
Commodity funds: These are generally made up of investments in raw materials and primary agricultural products, and can include assets such as gold, silver, oil, and gas. One example of a commodity ETF is the Commodity Strategies Fund (BICSX).
2. Choose your ETF
Once you know what the ETF landscape looks like, the next step is to narrow down your choices.
One way to do this could be to assess your shortlist against your personal investment goals, such as your risk appetite, any time limits you have, and your broader portfolio strategy.
3. Beware of the risks
Like all investments, ETFs aren’t risk-free, though they can offer benefits that lower your risk, such as diversification.
According to the ASX, the main risks of investing in ETFs are:
Market risk — If the broader market your ETF tracks falls, the value of your ETF is likely to go down with it.
For example, if the US stock market falls, an ETF tracking the S&P 500 will fall too.
Currency risk — if you invest in an ETF that invests in international assets, a change in the exchange rate between the two currencies will impact the value of your investment.
For example, let’s say you bought an ETF in Australian dollars but the underlying assets are US based. If the Australian dollar increases against the US dollar, the value of your ETF could fall in value.
Liquidity risk — if you can’t sell your ETF for a fair price.
For example, let’s say there aren’t enough orders to buy the ETF you’re trying to sell. While many ETFs are actively traded, others have low turnover, making buying and selling them for a fair price harder.
4. Find a broker & make your investment
When you’ve identified the ETF you wish to purchase, your next step is to find a way to invest in it.
Some funds let you invest with them directly. Others are only available for buying and selling on the stock market. This means you need to find a stockbroker or investing service that will allow you to make investments that meet your needs.
For example, at Spaceship, our US Investing service available through the Spaceship app, offers access to popular US ETFs through a US broker-dealer service, with low fees and low minimum investment requirements. You can even set up investment plans to take advantage of dollar-cost averaging, or Spaceship Boosts which invest your spare change or boost your account when it rains.
If you’re unsure of an offer, check to see if they’re on MoneySmart’s Investor alert list. It won’t guarantee your investment safety but it does show you which sites are missing the right licences or permission to offer investments in Australia.
