ETFs are exchange-traded funds, these funds are made up of many securities such as shares, bonds, commodities, and cash. An ETF is a fund of securities that typically can be traded on a stock exchange.
ETFs investments fall into two categories: Synthetic or physical. A synthetic investment is when the ETF is trying to replicate or track the performance of the index using derivatives. When you invest in such an ETF, you are not physically holding the asset, you are investing in an index that provides a return based on the asset’s price movement. For example, when you invest in gold or other commodity ETFs, you are not holding any gold or asset, but a derivative paying out based on the index related to the commodity.
On the other hand, a physical ETF purchased the underlying asset on the index it aims to replicate, such as shares. When you invest in such an ETF, it does not mean you own the assets but you own shares in the ETF that hold the assets. Compared to synthetic ETFs, physical ETFs usually have lower risks.
Most of the ETFs are passive investments, however, ETMFs or exchange-traded managed funds play a small portion of the ETF market. These ETFs are actively managed by fund managers, aim to outperform the market or deviate the underlying assets. ETMFs usually carry risks as the return is largely based on the skills of fund managers. And they usually charge higher management fees.
What are the Pros and Cons of investing in ETFs?
Advantages:
- A single ETF is diversified, when you buy a unit from it, you are investing in many shares and assets that fall into the category. Typically, an ETF invests in the index of top-valued companies such as ASX 200 and S&P 500, it can also invest in the shares that fall into the same category, such as technology and ESG.
- Some ETFs pay dividends when the underlying shares pay the dividends, these dividends can provide extra liquidity and franking credits.
- ETFs are easy to access, you do not need to have detailed research and a decent knowledge of the market, it’s easy to invest through brokers or platforms where they make your investment easy.
- ETFs have a relatively lower level of entrance, many funds or investments require a minimum investment of thousands of dollars and a fixed term. ETFs platform allows you to invest as little as a few hundred dollars.
- Free to exit. Unlike many of the investments that required a fixed or a minimum term. ETFs are open-ended. You can liquidate your ETF holding in a quick snap.
Risks:
- Like investing in shares. ETFs are not fixed-priced. The unit prices are constantly changing based on the value of the underlying assets.
- The liquidity depends on the market circumstances. Some ETFs are exposed to assets that are hard to liquidate in some circumstances, you are not provided by full liquidity, which increases your risks.
- Tax issues. When you get paid from dividends or get benefits from liquidating your investments. You need to pay taxes. Also, when you buy units in an ETF that is listed in a country other than Australia, you are required to pay foreign taxes.
Disclaimer:
All contents presented in this blog have been prepared for informational
purposes only, and are not intended to provide, and should not be relied on for any personal investment, tax, or accounting advice. You should, before making any decision regarding any information, strategies or product mentioned on this blog, consult your own financial or accounting advisors to consider whether the product is appropriate for you, based on your own objectives, financial situations and needs.
Reference:
Purcell, K. (2021, March 22). How to buy ETFs in Australia (2021) For beginners. Finder.Com.Au.
