A Beginner’s Guide to Exchange Traded Funds (ETFs)

A Beginner’s Guide to Exchange Traded Funds (ETFs)

Please consult a financial adviser, your tax accountant and the PDS to decide if any products mentioned here or elsewhere are right for you.

 

What Is an ETF and Why Should I Be Interested?

An ETF is an Exchange Traded Fund.

 

The exchange is the Australian Stock Exchange (ASX).

You can trade it — buy and sell your share of it, which is referred to as a unit.

Your investment goes into a fund, which is managed by a fund manager.

 

Why are they so popular?

ETF popularity is due to a few reasons: the ability for investors to easily diversify with one trade (of course make sure the trade only costs $9.50 with SelfWealth, otherwise you’re eating into your profits), they’re typically cheaper than managed funds, the ability to access foreign markets through the ASX (more on this later!), and transparency into holdings – you can see a daily disclosure of what the ETF is comprised of.

 

How Does an ETF Work?

Let’s use an example of a $10,000 investment into an ETF. You go into your online trading account and place an order for $10,000 of the Generic Australian Index ETF (not a real ETF…).

 

The fund receives $10,000 of new money and will then go out and individually buy the underlying assets that comprise that ETF – in the case of the Generic Australian Index ETF we’ll say it follows the ASX200 equally weighted.

 

The process is a bit more complex than this, but that is the general concept. The reverse happens if you wish to sell the ETF. Most of the time you don’t need to wait for the fund to sell or buy the underlying assets to buy or sell yourself.

 

What drives the price of an ETF on the ASX?

‘Supply and demand’ does not drive the unit price of an ETF, directly, as it would with shares in a company. As the fund manager is buying the underlying assets — company shares in SelfWealth’s case — the values of those companies are what drives the price of a unit in that ETF. If those companies perform well, your ETF unit goes up in value.

 

The more people that buy the ETF, the more the ETF goes out and buys the underlying assets. As with selling, they will sell the assets to allow that investor to exit.

 

What Fees Does an ETF Charge?

A common question we’re asked is about the fees an ETF charges. This is separate from your brokerage fees, when buying or selling your unit in the ETF. It’s not something you need to worry about paying at any stage, it automatically comes out of the fund.

 

Most funds will include this fee in the calculation of performance, it’s typically referenced as ‘net of all fees’. This is how the ETF manager generates revenue. The more money in a fund, the more revenue they generate.

 

There are typically no “performance fees” or the like — the fund will display all the fee information on their website so make sure to check there before investing.

 

Easy Access to International Markets.

Accessing international markets directly via their respective exchanges (e.g. NASDAQ and NYSE for the US, LSE for the UK) can be quite cumbersome to set up, as well as expensive when exchange rates are taken into account, on top of (typically) more expensive brokerage fees.

 

Some Australian ETFs, which as explained above buy their underlying assets, can cover international markets — US, Europe, Asia. You don’t need a different trading account or worry about exchange rates, although these will be worked into the ETFs fees as outlined above, and an ETF typically offers access in a more affordable fashion. Some managers and platforms locally may have higher fees than an ETF.

 

And of course, you will naturally get diversification in those markets with an ETF, too.

 

There may be additional work required in regard to tax via these international ETFs, so please ensure you speak to the fund manager and your accountant.

 

What Are the Best ETFs in Australia?

The question asked most of all! There is so much choice, so which one to choose? SelfWealth have a target portfolio option for ETFs, which allows you to automatically align your portfolio with the top 10 ETFs as held by the best investors from the 50,000+ strong community. Keep an eye out on the blog or create a trading account with SelfWealth to access this list.

 

What Are the Different Types of ETFs?

This is getting into more advanced concepts of ETFs, so we’ll cover off the difference between Passive, Active and Smart-Beta ETFs in another post shortly.

 

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