What is an ETF?
The question what is an ETF is emerging among investors more often today. ETFs (exchange-traded funds) are a popular way of investing. Many investors are considering adding exchange-traded funds in their portfolio. This article will explain what they are about and answer the most important questions.
So let’s start with the main question.
What is an ETF?
ETF is a type of investment that you can buy or sell through a brokerage firm. They have the same function as regular stocks.
ETFs most often track market indexes, but they can also track various sectors, precious metals, or other assets.
What is very appealing about them is the simplicity and low cost. Considering there is no need for highly paid analysts and managers, management fees are very low.
Is ETF worth investing in?
ETFs allow investors to diversify their portfolios at a low cost. Moreover, they provide great liquidity since they can be traded every day on the stock exchange. It is considered a good investment for someone who likes the stated benefits.
What Is the Difference Between ETF and Mutual Funds?
Both mutual funds and ETF offer diversification as they hold portfolios of over 100 securities.
Mutual funds are actively managed and ETFs are passively managed.
ETFs are actively traded throughout the day while mutual funds trade at the end of the day. Therefore ETFs offer higher liquidity than mutual funds.
Fees are usually higher for actively managed mutual funds than ETFs.
Since most ETFs track indexes, their return will be like the return of indexes. On the other hand, mutual funds can beat the return of the index and thus achieve a higher return to the investor, but they can also lose against the index and thus return less to the investor.
What Kind of ETFs Are out There?
ETFs can hold thousands of stocks in a variety of industries, sectors, or assets. If we look at what they invest in, they can be divided into following categories:
- Fixed-income ETFs. They include government or corporate bonds.
- Equity ETFs. They track an index of equities.
- Sectoral ETFs. They track the shares of a particular industrial sector such as technology, finance, health, energy, etc.
- Commodity ETFs. They invest in commodities traded on the stock exchange.
- Currency ETFs. They invest in either a single currency directly or a basket of currencies.
What Is the Difference Between Synthetic ETFs and Physical ETFs
Physical ETF
The physical ETF purchases the instruments contained in the index it tracks. To clarify, let’s look at CSPX (an ETF that tracks SP500). If you look at the factsheet, you will see that CSPX holds 5,7% of AAPL which is the same percentage as the index SP500 holds. In other words, CSPX tracks the S&P 500 index.
Therefore, it holds the same proportions of the shares of the companies included in that index (measured at the value of market capitalization).
However, ETFs that track a particular index do not always match completely. An ETF can also hold only a sample of the index.
Synthetic ETF
A synthetic ETF does not invest directly in an index. It is designed to replicate the return of a selected index using underlying securities or assets. In short, a synthetic ETF does not physically possess any instruments. They use swaps and collateral to replicate returns.
What Is the Cost of Owning an ETF?
One of the main advantages of ETF is its low cost. The cost you have to pay when you hold an ETF is easily found in every factsheet of an ETF under the name “expense ratio”. It depends on which index, industry, or asset it tracks. However, most often total cost varies between 0,01% and 0,85% in annual fees. For example, the iShares ETF CSPX that tracks the SP500 costs 0.07% annually.
What Is the Average Return of ETF?
Since ETFs are very diversified, for the average return we can take the market index SP500. The S&P 500 index has had an average annual return since its inception of 10%. Therefore, the average return of ETF is also around 10%. It should be taken into account that the average return of an ETF depends on both the market movement and the index it follows.
Do ETFs Pay Dividends?
If you buy an ETF that contains dividend-paying shares, then the ETF will also pay you those dividends. Most often dividends are paid quarterly or once a year from ETFs.
Where can I find information about ETFs?
There are many sites where you can find information about ETFs. If you want to find any ETF you should be able to do so on ETF.com or justETF. Furthermore, you can also view information on the ETFs of the biggest publishers directly on their website. Here are the links to the three biggest:
Each of them contains a large number of ETFs, but they are not the only ones, there are many others equally good ETFs.
Which ETFs Are Recommended by Top Investors Like Warren Buffet?
ETFs have been recognized as an important form of investment by some of the largest investors. We can often hear from the Warren Buffet advising the average investor to invest in a low cost S&P 500 index fund. Ray Dalio holds in its portfolio the ETFs that track the S&P 500, gold, Chinese and developed markets.
Conclusion
ETFSs are an important investment instrument today and offer some advantages as well as disadvantages over other instruments. They offer good diversification, low costs and higher liquidity. On the other hand, they follow the market index, so significantly higher yields cannot be expected.
They are easy to invest in and some of the biggest investors recommend them and even have them in their portfolios.
ETFs are considered a passive investment that can increase your passive income. I have already written about why intelligent investor need passive income. Also, I wrote about the best passive income ideas in 2021. So, feel free to read them if you haven’t already.
To sum up, you should weigh the advantages and disadvantages of ETFs and see if it fits your investment goals. If it fits, inform yourself even more until you are completely sure that you have made a quality decision.