What are ETFs
An Exchange Traded Fund (ETF) is a type of fund that is listed and traded on the stock exchange. The underlying assets within an ETF can range from ordinary shares, bonds, commodities to futures. ETFs mainly aim to track the underlying asset and not outperform it. As such they provide a great opportunity to diversify your portfolio and gain wide access to sectors and markets.
How do ETFs work
ETFs are funds that are divided into shares and traded on an exchange just like ordinary shares. Their pricing is also updated throughout the day. The assets within an ETF are usually related, such as Equity ETFs, Bond ETFs and Currency ETFs. An example would be one of the many ETFs that track the ASX 200 index. This means the ETF will hold the companies that make up the ASX 200 index. This fund will aim to closely track the performance of this Index.
Types of ETFs
There are limitless types of ETFs available. The main types include:
- Broad-market ETFs - These are the most popular ETFs. They aim to track a broad index such as ASX 200 or FTSE 100.
- Sector ETFs - They allow access to industry sectors, such as the financial sector, health care, technology and energy sectors.
- Dividend ETFs - Dividend ETFs invest in dividend yielding stocks. There are different strategies and they are outlined by the fund provider.
Benefits of ETFs
- Diversification - ETFs allow access to a broad range of securities. ETFs can help you diversify your investment across multiple assets.
- Access to other markets - ETFs allow access to markets not easily accessible, such as overseas indices and other market sectors.
- Liquidity - ETFs are trading on the exchange the same way as a normal stock. This allows great liquidity compared to other types of funds.
- Transparency - ETF managers are under ASIC obligation to regularly disclose to the market what the underlying assets are.
Disadvantages of ETFs
- Ownership control - No direct ownership of ETFs' underlying asset.
- Currency Risk - If the ETFs' underlying assets are international assets, there may be a currency risk, if the ETF is not currency hedged.
- Tracking Errors - An ETF aims to closely track the underlying assets. Due to factors such as illiquidity and management fees there may be tracking errors.