What Is An ETF and Why Are They So Popular?

If you’ve recently started investing your funds you may have come across the term Exchange Traded Fund or read the term exchange-traded funds.  And you may have asked yourself what is an ETF?

An Exchange Traded Fund (ETF) is a simple, low-cost fund that provides investors with a benchmark return at minimal cost.  ETF’s can be bought and sold on a securities exchange market and generally do not try to outperform the market.

ETF’s have been around since 1993. They have gained significant popularity in the last decade.  Their low cost and flexibility allow investors to diversify their funds by purchasing a diverse range of assets at once in a single transaction.

ETF’s offer investment exposure in a very broad range of assets including

Australian shares, international shares, fixed income products, foreign currencies and precious metals and commodities. There are two type of ETF’s  in the market for investors use. They are;

  • Physical ETF’s and
  • Synthetic ETFs.

‘Physical’ or standard ETF’s acquire the underlying investment, such as shares or other assets on the reference index which the ETF is investing in. 

As an investor,  you will own shares or units in the ETF. When you invest in an ETF, the ETF owns the underlying investment and you, the investor, will own shares or units in the ETF’s. 

Your investment risk then is the performance of the underlying shares or assets.

A synthetic ETF like a physical ETF is designed to track a particular index.  They are a type of managed investment that can be bought or sold like shares.

However, a synthetic ETF relies on derivatives provided by financial institutions to execute their investment strategy.  This means that rather than physical holdings they rely on synthetic holdings of the underlying shares or other assets, which they aim to replicate.

ETFs have often been regarded as better than managed funds (Click here to read up on Managed Funds Versus Exchange traded funds) for a wide number of reasons including;

  1. Low administration costs
    Compared with managed funds, ETF’s can be significantly cheaper to invest.
  2. Live trading
    ETF’s are traded on the stock managed funds need to wait for the market to close in order to create a unit for the day. This delay can cause potential time lagged disadvantages to an investor.
    Just like a stock’s an ETF can fluctuate in price as well. The advantage of holding an ETF is the trading flexibility.It allows you to buy an ETF that was trading at $60 at 10:00 and sell it for $65 by 12:00 on the same day.

It is important to note that some products that also track indexes or other investments may appear to be an ETF but are not.

Products that are labelled “exchange-traded commodities”, “exchange-traded notes”, “exchange-traded certificated” and exchange-traded securities” are not ETFs.

As with any investment, choosing to invest in an Exchange Traded Fund is always best paired with professional financial advice.  Before taking any steps consider speaking with a Financial Adviser who can not only provide you with further insight on ETFs but will also choose the best investment option for you based on your risk profile.

LifeTime Financial Group are specialist (holding appropriate accreditations) advisors who are ideally positioned to assist you.

Would you like to discuss your personal position further with one of our highly qualified financial planners? Why not call us today on 03 9596-7733. There is no cost or obligation for our initial conversation/meeting.

Written by Anthony Stedman of LifeTime Financial Group. A leading privately owned Melbourne based Financial Planning practice.

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