As a beginner to the world of investing, you’ll come across a number of terms you’re unfamiliar with. One of those is an ETF or exchange-traded fund.
ETFs bring together the best of both worlds: the diversity of different assets and the flexibility of stocks. In this guide, we’ll explain what exactly an ETF is, how they work, the differences between various ETFs, as well as some other information that can help you on your investment journey.
ETFs can pool together a range of investments from across sectors or regions.
Some investors buy into ETFs because they can be cost-effective and transparent.
The simplicity of ETFs may be appealing for beginners who may be overwhelmed by choosing individual stocks.
While they may help to diversify your portfolio, make sure any new ETF investments are still in-line with your long-term investment goals.
ETFs are investment tools that trade on stock exchanges, just like individual stocks. They are a collection of different assets – such as stocks, commodities or bonds, bundled together into a single fund.
Some of the more popular ETFs work by ‘mirroring’ an index, like the S&P 500 or NASDAQ. This mirroring effect means investors can get greater exposure to a wide range of assets within a single investment, therefore spreading their risk across different sectors or markets.
Many ETFs are passively managed, which means they strive to match the performance of their underlying index rather than trying to outperform it actively. This often results in lower management fees compared to actively managed funds, which we will discuss a bit further down.
Ultimately, these funds could provide you with a convenient way to diversify your portfolio and get exposed to various asset classes.
When you buy an ETF, you’re buying units of the fund, not the actual underlying assets or individual stocks within the fund.
Units represent the level of ownership of the ETF’s entire holdings. For example, if a fund holds numerous different stocks, then buying a unit of that ETF gives you exposure to all those stocks in the same proportion as they are held within the fund. When the underlying index goes up or down, the value of the ETF generally moves in the same direction.
Here are just a few of the different types of ETFs and how they work:
Index ETFs: These mirror a specific stock index like the S&P 500. They try to replicate how that index is performing by holding similar securities in the same amount.
Fixed income ETFs: Investing in bonds or debt securities brings regular interest payments. They are generally less volatile compared to stocks.
Currency ETFs: These funds track the value of a single currency or a basket of currencies. With a currency ETF you can speculate on currency movements or hedge against currency risks.
Commodities ETFs: Giving you exposure to commodities like gold, oil or agricultural products. Depending on the fund, it may be physically backed (i.e. holding the actual commodity) or futures-based (i.e. investing in futures contracts).
Sector ETFs: Focused on specific sectors like technology, healthcare, mining or energy.
ETFs generally pass on any dividends received from the stocks or bonds in their portfolio. How often and how much an ETF pays its investors can differ according to the underlying assets it holds.
It’s always a good idea to do your own due diligence before investing in an ETF for the purpose of receiving dividends. You can check the fund’s prospectus or other available documents to find out about its dividend policy and how often it pays out to investors. Dividend yields can vary, so think about your goals and preferences when selecting funds.