ETFs: The Basics

Exchange-traded funds (ETFs) have emerged as one of the most popular investment vehicles in recent years. These funds have gained immense popularity among investors due to their low fees, tax efficiency, and flexibility.

ETFs have made it easier for investors to gain exposure to a diverse range of assets, including shares, bonds, and commodities, without the need for a significant amount of capital.

In this article, we will explore the world of ETFs, their benefits, and how they work.

What REALLY is an ETF?

An ETF, or exchange-traded fund, is a type of investment fund that holds a collection of shares, bonds, or other assets. It is similar to a managed fund, but unlike a managed fund, it trades like a share on a stock exchange. This means that they, like other listed shares, can be traded during the day.

When you buy an ETF, you are essentially buying a basket of securities that focuses on a particular theme. For example, passive ETFs track the performance of a specific index, such as the S&P ASX 200, while you can also purchase ETFs that concentrate on bonds or a particular industry or currency. ETFs are designed to provide investors with exposure to a particular market or sector while offering the diversification benefits of a portfolio of securities.

ETFs are popular because they offer investors a low-cost way to gain exposure to a diversified portfolio of assets. They also allow investors to trade in and out of positions quickly, and they offer greater transparency and tax efficiency than traditional managed funds.

Key Features and Risks of ETFs

ETFs enable single-trade exposure to many investments. Professional fund managers have access to information, research, and investment methods that may improve returns or reduce risk. Yet, as with any other investment, the bigger the expected return, the higher the risk and variability of returns.

ETF Benefits

Buy/Sell Flexibility

ETFs are bought and sold on the ASX, which means ETF investors can buy and sell them during the ASX’s trading hours. As a result, you can enter and leave an ETF investment just like a share, with a two-day settlement period.

Diversification

ETFs can help you diversify across asset classes, industries, and geographies. ETFs cover emerging markets, market sectors, government and semi-government bonds, commodities, and currencies.

Lower Cost

ETFs often have lower operating costs and management fees than other types of professionally managed investments, as measured by the fund’s expense ratio.

Growth and Income

ETFs will fluctuate in value when the underlying assets fluctuate. Investors can earn returns through price increases and/or payouts, depending on the type of product and the benchmark being monitored.

Fair Value

ETFs are intended to trade near their underlying net asset value (NAV). This means that the market price should accurately represent the underlying assets’ fair value.

ETF Risks

Market Risk

In some cases, buying or selling ETFs may be challenging due to market conditions (such as a lack of liquidity in volatile markets). An ETF’s return occasionally may differ from the return of the benchmark or index it is trying to track.

Regulatory and Tax Risk

The risk that a government or regulator may modify regulations or taxes, affecting the ETF’s securities, units, or tax treatment.

Foreign Investment Risk

Countries may experience market, economic, and political volatility causing international shares to suffer. Global investing also involves currency risk. Non-Australian currency investments will depreciate if the Australian dollar rises.

Taxation Outcomes

ETFs are taxed differently than shares. Your tax assessment must include ETF distributions as income. Different asset classes have different tax treatments. You should talk to a tax expert for advice that takes your financial situation into account.

Derivatives

Particular risks apply to ETFs that use derivatives to replicate an asset or index. ETFs that use over-the-counter derivatives without central counterparty clearing arrangements are more exposed to counterparty risk.

Liquidity

ETF liquidity risk exists. If the underlying assets or basket of assets market becomes illiquid, so will the ETF product.

Fund Specific Risks

Depending on their investment strategy or assets, ETFs may have significant risks. ETFs that borrow or leverage may increase risk.

6 Steps When Investing in ETFs

Since you can buy or sell ETFs on the share market, the process is similar to buying shares.

1. Open a brokerage account. There are different ways to open a brokerage account, such as through a financial adviser, bank or online broker service. When choosing a brokerage, it is important to consider fees, minimum deposit, types of assets, customer service, special features, and financial advice and planning.

2. Create Your ETF Investing Plan. Determine how much you’ll invest, your risk appetite, your goals and your investment timeline as a guide for your asset allocation.

3. Research the ETFs most likely to help you reach your goals, using ETF research tools and third-party databases. It may be best to seek the advice of an experienced financial adviser who can tailor an investment plan to your needs.

4. Purchase the ETFs. In general, the process is like buying a share.

- Fund your account.
- Search for the ETF ticker symbol.
- Enter the number of shares you want to buy.
- Confirm the order.

5. Create a Purchasing Strategy. Buying ETFs regularly may help you to reach your investing goals if it is in line with your financial strategy, and using dollar-cost averaging could help you pay less per share over time.

6. Plan Your Exit Strategy. Think about how to sell your ETFs to minimise capital gains taxes or capital losses.

Are ETFs Popular?

ETFs, or exchange-traded funds, have grown in popularity among Australian investors in recent years.

According to the latest research from BetaShares, the Australian ETF industry ended March 2021 with a record high of $102.9 billion in funds under management, up 32% from a year earlier. In fact, ETFs were the fastest-growing investment category in Australia in 2020, with net inflows of $15.5 billion, accounting for more than 60% of total industry inflows.

The report also found that equity ETFs were the most popular, followed by fixed-income and multi-asset ETFs. The low cost, transparency, and diversification offered by ETFs are some of the reasons why they have become an attractive option for Australian investors looking to gain exposure to different asset classes.

The Cost of Trading ETFs

ETFs have gained popularity as an investment option in Australia due to their low costs and diversified exposure to a range of asset classes. However, investors should be aware of the costs associated with trading ETFs.

The most significant cost is the brokerage fee, which is charged by the broker for executing the trade. In Australia, the brokerage fees for ETFs are generally lower than those for buying and selling individual shares, but they can still add up, especially if you are making frequent trades.

Additionally, some ETFs charge management fees, which are deducted from the fund’s assets and can eat into your returns over time.

Finally, investors should be aware of buy-sell spreads, which are the difference between the price at which you can buy an ETF and the price at which you can sell it. This spread can vary depending on the liquidity of the ETF and can also impact your returns.

Ready to Build an Investment Portfolio?

When investing in ETFs or any other investment vehicle, you should consider doing it along with your other financial instruments to diversify your financial plan – a financial adviser can help you with this.

While investing can seem complicated and time-consuming, it doesn’t have to be that way with knowledge and expert guidance. Whether you’re young or old, it’s never too late to start investing for your future.

Need investment advice? Newcastle Financial Planning Group is here to help you tailor your investment plan and build your portfolio. Our financial advice team can help you establish direction for your investments to achieve your financial and lifestyle goals.

Call us or book online to secure your consultation today!

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