Stocks. Bonds. Gold. Properties. There are already plenty of investment options for the individual investors to look into. There are already plenty of tried and true strategies written by experts to increase gains and minimise losses in these classic choices, spanning decades’ worth of history. Why should we pay attention to one more investment option, especially one that is relatively new like ETFs (Exchange Traded Funds)?
If you are new to ETFs, this beginner’s guide can offer you the overview you are looking for.
Exchange Traded Funds have been around for some time, but gained considerable traction from 2006 onwards. In 2015, it has surpassed mutual funds in popularity, according to the survey results of 2015 Trends in Investing Survey: Where Financial Advisers are Investing Now‘. The survey was taken from 303 online financial advisors, most of whom (97%) are CFP™-certified. Let that sink in for a bit – ETFs is now preferred over mutual funds, once the ‘default’ and ‘safe’ approach to successful investing.
What is ETF?
Investopedia defines ETFs as a ’marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund.’ (x) ‘Tracking’ here is a key word – ETFs operate by following the performance of a category of your choice on a macro level.
ETFs have qualities of both mutual funds and stocks. Like mutual funds, ETFs can cover a large sector and can be a great diversification strategy. Like stocks on the stock market, ETFs can be traded and have different prices throughout the day as investors buy and sell. It is also possible to ‘short’ ETFs.
However, unlike mutual funds or stocks, a person who invests in ETFs does not directly own a ‘share’ in a company, but rather ‘entitlement to a proportion of the profits’ instead. Another big difference is that ETFs are usually passively-managed (by ‘tracking’), which means that fund managers (or investors) do not take active roles in its management – one of the reasons why it can offer lower fees than mutual funds.
Types of ETFs You Can Get
It is important to know that the ETF market is still evolving and shaped by consumer demands. As a result, ETF products can be incredibly wide and incredibly niche.
Some examples of ETFs include:
- Bonds ETFs (Mortgage-backed Securities, US Municipal Bonds, Long-term bonds)
- Commodity Price ETFs (Agriculture, Energy, Metals and Minerals)
- Currencies ETFs (Chinese Yuan, US Dollar, Currency Basket)
- Market Indexes (NASDAQ 100, S&P 500)
- Real Estate
- Industry-based ETFs (Financial Services, Health Care, Natural Resources, Utilities)
- Stock ETFs by Investment Strategy (Ethical ETFs, Technical Analysis ETFs, Shariah Law ETFs)
- Stock ETFs by Investment Styles (Large Cap, Small Cap)
- Stock ETFs by regions (US, Europe, Emerging Market)
The list above is not exhaustive – ETFs can also include temporary market trends and other short-lived options. ETFs in different sub-categories can also track more or less the same things and thus can overlap, so it is important for you to find out the subtle differences between them. As a start, you can find one version of ETF sub-categorisation here.
Should You Consider ETFs?
The best investment vehicle is the one that you understand the most. If your investment background includes mutual funds and stocks, and/or if you are familiar with how they work, you will have an advantage over this investment option. ETFs can accommodate many investment strategies – the range of options that ETFs offer can make a great addition to many investment portfolios.
Like all investment vehicles, ETFs also carry its own advantages and disadvantages. We covered the basic advantages above: lower cost, great for diversification, and large selection. As for disadvantages, here are some flaws you should know before you decide to invest in ETFs. We should also point out that ETFs’ long-term drawbacks are not known since they are still relatively new. Nonetheless, they are definitely worth looking into as an option.