What the ETF?
Let’s take a closer look at Exchange traded funds.
As the name suggests, ETFs are funds that trade on the Exchange, like shares or stocks. ETFs allow you to diversify your portfolio without all the time and effort you would usually spend managing and allocating your investments individually. So, when you buy an ETF, you buy into multiple securities wrapped into one investment.
Remember, ETF shareholders do not directly own shares of the stocks. They own shares of the ETF itself. As an investor, you can sell shares of your ETF on an exchange, much like a stock.
So, instead of having all your eggs in one basket (where all the eggs are the same), think of your ETF as a shopping basket filled with different products. The diversification of ETFs allows you exposure to multiple, even hundreds of securities in a single portfolio. It is far easier to manage than if you were to buy them individually.
Types of ETFs (exchange traded funds)
There are two broad types of ETFs:
- Passive ETFs
- Active ETFs.
When most people think of ETFs, they’re thinking about passive ETFs, otherwise known as ‘Index Funds’, because they match the performance of an index such as the S&P500. Active ETFs are actively managed by a portfolio manager who attempts to outperform the index.
Many ETFs track an underlying index representing other securities or asset types, such as stocks, bonds, commodities, or currencies.
An ETF that tracks the JSE Top 40, for example, lets you own shares in the Top 40 biggest companies on the JSE—all in a single trade.
There is an exciting array of ETFs, but these can generally be broken down into six categories: equity, fixed-income, commodity, currency, real estate, and speciality ETFs:
- Equity ETFs: These give you access to dozens of sub-categories with some of the more common equity ETF types, such as the S&P 500 (Standard & Poor’s 500 is a stock market index that tracks the performance of the 500 largest US companies listed on the stock exchange.
- Fixed-Income ETFs: Also known as Bond ETFs, these funds track bond market indices and common fixed-income ETF categories such as government bonds, corporate bonds, tax-free municipal bonds, international bonds, emerging markets bonds and high-yield bonds.
- Commodity ETFs: These ETFs track the price of a commodity, for example, gold, oil, or other commodities such as precious metals, rather than holding the asset physically.
- Currency ETFs: Just as with commodities, currency ETFs give the everyday investor access to currency markets and foreign exchange trading (Forex).
- Real Estate ETFs: With these ETFs, an index of publicly traded real estate investment trusts, or REITs, is tracked. These are typically companies that own, operate or finance income-generating real estate. Real estate ETFs are often for investors seeking high-yielding investments
- Specialty ETFs: One of the exciting advantages of ETFs is that they allow investors access to diverse sectors of the economy. For instance, niche market areas, such as technology, or even more narrow technology sub-sectors, such as Semiconductor ETFs or Artificial Intelligence ETFs. Other speciality ETF sectors include healthcare, industrials, consumer staples, consumer discretionary, financial services, and utilities.
Now we know about the types of Exchange traded funds, we can look at steps to invest in them.
How to invest in an index fund (it sounds heavy, but it’s not)
If you’re new to investing, ETFs are attractive because you can invest in them through any regular trading platform.
ETFs have a minimum investment requirement of a few hundred rands rather than a few thousand rands for unlisted funds. So, here are 4 steps on how you actually go about investing in an ETF:
Choose an investment platform. This will require opening a brokerage account with an investment platform. Remember, not every platform gives you access to every ETF.
Do your homework, especially if you are a beginner to ETFs. Passive ETFs (index funds) are ideal because their fees are lower than actively managed funds, and they perform relatively well over time.
Deposit funds and buy your ETF (you will need to deposit funds into your account to do this). You will generally pay a smaller fee (called the MER fee) to the ETF manager out of your returns.
BE PATIENT. One of the biggest reasons that ETFs underperform is that beginner investors panic when things may dip a little and make impulsive decisions.
Nothing in life is risk-free. Including ETFs. Here are a few things to bear in mind when investing in ETFs:
• Trading fees: ETFs are low-cost, but because they trade like stocks, each transaction charges a commission, which can lower your return.
• No guarantees: Like all investments, ETFs carry some risk. However, this is minimised because ETFs hold dozens or hundreds of securities in a single packaged security. As an investor, you can further reduce risk by investing in various ETFs from diverse categories.
• Lower potential return than individual stocks: Because ETFs bundle different investments into one package, they may not have the same potential return as an individual stock.
We’ll leave you with the words of the revered investor Warren Buffet, “Keep buying (ETFs) through thick and thin, and especially through thin.”