Created in the 1990s, ETFs have gained popularity in the investing world due to their affordability and convenience as a way to get a diversified set of investments, but what exactly are they and how do they work?
It’s a ready-made basket of investments
Standing for Exchange-Traded Funds, ETFs are like an investment hamper containing a pre-packed selection of assets. They come in all shapes and sizes. Some contain just one type of investment, like shares, bonds, property, or commodities, whilst others will hold a mix of them. They can also contain investments from just one stock market or region, or from several. This means that buying ETFs allows you to quickly and easily spread your money across a number investments and markets, which can help to mitigate your risk.
It’s traded on the stock exchange
ETFs were developed by investors frustrated by the inability to trade traditional investment funds during the day. ETFs can be traded throughout the day, which can allow you to take advantage of price fluctuations and buy or sell lots of investments all at once. This makes them useful as both active investing and passive investing tools, and versatile for investors. At first, ETFs were the preserve of professional investors, but they soon became mainstream and today there are over 4,0001 ETFs worldwide, available to individual investors via a raft of DIY investing platforms. However, if you don’t have time or aren’t confident enough to choose from the thousands of ETF options yourself, you could get a digital wealth manager like Wealthify to pick them for you.
It tracks markets
Most ETFs are designed to track a market index such as the FTSE 100 which follows the performance of 100 very large UK companies and the S&P 500 regrouping stocks from 500 large US companies. As a result, the performance of your total investment mimics markets you're tracking - if they go up, your portfolio grows, and vice-versa. This style of investing is known as passive investing as you typically ‘buy and hold’ your investments over the long-term, ignoring day to day market price changes in the hope of good year-on-year market growth.
When you buy an ETF, you have to pay a fund charge, which is usually cheaper than actively managed funds. The London Stock Exchange found that an emerging market equity ETF would typically cost around 0.56%2, whereas an actively managed mutual fund from the same place would cost on average 1.76%2. Of course, there may be other charges you have to pay on top, depending on where you buy your investments, so it’s worth checking what they are. For example, if you decide to buy your own ETFs via an investing platform, you might pay a platform fee, and sometimes a broker fee. If you choose an online investing service, like Wealthify, you’ll tend to pay a flat annual management fee that covers all the associated costs of investing, along with the fund charge.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.