What is an ETF (exchange-traded fund)?

Exchange traded funds (ETFs) give investors the best of both worlds: the ease of stock trading plus the diversification benefits of managed funds.

man buying fruit
man buying fruit

iShares ETFs & BlackRock Funds cover a broad range of asset classes, risk profiles and investment outcomes. To understand the appropriateness of these Funds for your investment objective, please visit our product webpages.

Find out more about our products: https://www.blackrock.com/au/products/investment-funds

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What is an ETF? Exchange traded funds explained

A short introduction to exchange traded funds. Learn what an ETF is, how it trades on an exchange like a share, and how ETFs can help Australian investors build a diversified portfolio.

What’s an ETF?

Exchange-traded-funds, or ETFs, are like managed funds in that they invest in a basket of securities, such as stocks, bonds, or other asset classes. But unlike managed funds and similar to a stock, ETFs can be traded whenever the markets are open.

By combining the diversification benefits of managed funds with the ease of stock trading, ETFs can provide investors with a simple way to access the world’s financial markets.

What are the benefits of investing in ETFs?

ETFs can offer exposure to a portfolio of securities representing specific asset classes, sectors, countries or segments of the bond market.

Whether it’s at the shops or the petrol station, a dollar saved truly is a dollar earned. The same is true when it comes to your investments, where keeping costs low can help you reach your goals sooner. Even small fees can have a big impact on your portfolio because not only is your balance reduced by the fee, but you also lose any return you would have earned on the money used to pay the fee.

ETFs typically cost less than comparable managed funds. Buying an ETF can also be more cost effective than buying the same basket of securities individually.

Most investors would generally agree that the primary goal of investing is to generate the highest possible return for the lowest risk. Diversification can help you obtain this balance. By spreading investments across asset classes, geographies and sectors, investors lower their risks as the poor performance of one investment should be offset by stronger performance in another, and vice versa.

ETFs generally track indexes that are comprised of many individual securities, helping to spread the risk and insulating investors from the impact of price swings in any one security. Although this does not eliminate risk entirely, the diversified structure of ETFs has the potential to improve the risk-adjusted return of your portfolio.

Diversification does not guarantee a profit or eliminate the risk for potential loss.

The high liquidity of ETFs – the speed with which they can be bought and sold – comes from the markets on which they are traded. ETFs trade on exchanges and investors can buy or sell throughout the trading day, just like shares.

And just like shares, you can buy and sell ETFs in a variety of ways:

  • Limit order - the order is executed only at the price specified, or better. This avoids an unexpected outcome at times of higher market volatility or potential wider spreads.
  • Market order - the order executes as soon as possible at the best price available at the time. However, all or part of the trade is at risk of being traded at a value different from the last trade’s price, especially in times of market volatility or lower liquidity.

The ease of trading ETFs gives investors more control over when and how they trade. This high-liquidity feature is one of the key benefits of owning ETFs, particularly when compared to managed funds. To learn more, read Trading ETFs.

Knowing exactly what you own is important information you need to make financial decisions. ETFs are straightforward and transparent about their investment objectives. In addition, information on ETFs holdings, performance, and portfolio characteristics are published daily and freely available on the product page for each ETF.

While iShares ETFs disclose holdings daily, that generally only happens monthly or quarterly with managed funds. Because of their longer disclosure cycle and the greater flexibility that active fund managers have when choosing investments, some managed funds have historically been affected by what’s known as “style drift.” Style drift occurs when a fund’s holdings change over time and sometimes stray farther from the fund’s intended strategy than investors may realise. With ETFs, you’ll always be able to know what you own and don’t have to worry about style drift.

What are the different types of ETFs?

Exchange traded funds may trade like stocks, but under the hood they more closely resemble managed funds, which can vary greatly in terms of their underlying assets and investment goals. In this section, we explore the structures used to build the ETF.

Index ETFs seek to replicate the performance of an underlying index, like the S&P/ASX 200. The vast majority of ETFs are index funds – also known as ‘passive’ funds – which typically trade less frequently than traditional active managed funds.

Active ETFs seek to outperform a specific index – or achieve a specific outcome such as maximising income – by underweighting or overweighting certain securities relative to their index weighting. Both active and index ETFs are professionally managed, but active ETFs typically require more monitoring and trading by the portfolio managers, which can result in higher fees.

Equity ETFs invest in a basket of individual stocks. There are stock ETFs covering specific sectors, from technology and healthcare to consumer goods, as well as ETFs that provide exposure to international stocks, including regional, country-specific and sector-focused ETFs. For example, one of the largest equity ETFs is the iShares S&P 500 ETF (IVV), which aims to mimic the performance of the S&P 500. In addition, there are equity ETFs that focus on size or a particular investing style, such as minimum volatility.

Bond ETFs, also known as fixed-income ETFs, provide investors access to multiple bonds in a single trade. As with stock ETFs, bond ETFs trade on exchanges. Trading on exchanges provides greater liquidity, and transparency in pricing and execution, which is particularly beneficial to investors.

Bond ETFs come in a wide variety of sub-sectors; these include Australian Government bonds and corporate bonds or international government debt, as well as specific sectors such as high yield corporate bonds, and emerging market debt.

Commodity ETFs track the price of physical assets such as gold, oil and wheat. Commodity prices are generally not highly related to prices for stocks and bonds. Commodities also tend to rise in tandem with inflation. For these reasons, investors often use exposure to commodities to help diversify their portfolios, and to align with their views on inflation and the economic outlook.

Sector ETFs offer investors exposure to a basket of companies in specific industries such as consumer staples or healthcare. Sector ETFs provide investors an opportunity to express their views on a particular industry while limiting their exposure to the risks of owning individual securities.

What is the difference between an ETF and a managed fund

Both exchange-traded funds (ETFs) and managed funds are professionally managed portfolios of stocks, bonds and/or other income vehicles devoted to a specific investment strategy or asset class.

ETFs can be traded on an exchange just like a stock. While managed funds are purchased directly from the fund company and priced once daily, after the market closes.

ETFs and managed funds both enable investors to access diversified portfolios. You can buy or sell both ETFs and managed funds directly through your brokerage account, or via a financial adviser.

But ETFs and managed funds differ in how they trade, how taxes are handled, and how investors interact with them. Understanding these differences can help investors choose the structure that best aligns with their investing goals and preferences.

ETF vs Managed funds: Key differences

Caption:

Compare the differences between ETFs vs Managed funds with regard to trading, tax efficiency, fees, and transparency.
ETFsMANAGED FUNDS
TradingETFs are traded on exchanges throughout the day, just like stocks. When you place an order to "buy" or "sell" an ETF, you can see the current market price at which it is trading.Managed funds are bought and sold directly from the managed fund company at the current day’s closing price. As a result, everyone who places a "buy" or "sell" on a given day will receive the same price, regardless of what time of day their order is placed.
FeesETFs typically cost less than comparable managed funds (40% on average)¹ and offer investors transparency on fees.Managed fund transaction fees may include sales loads (or sales charges) or redemption fees, which are paid directly by the investor.
TransparencyETFs generally disclose their holdings on a daily basis.Managed funds generally disclose their holdings on a quarterly basis.

How do I invest in ETFs?

There are a variety of ways to invest in ETFs, which largely comes down to personal preference. For hands-on investors, investing in ETFs is but a few clicks away via your online broker. For other investors, they may want to consult a financial adviser to help them construct a diversified portfolio using ETFs managed by investment professionals.

For investors wanting to be more hands-on with their investments, below are some considerations when selecting an ETF:

Everyone's investment needs are unique. Whether your goal is maximising growth, generating income, managing risk, or other objectives, you need to create a plan — and stick with it.

After setting goals and comparing ETFs, go deeper to learn more about how each ETF measures up on key metrics, including performance, risk, cost, and core holdings. Explore iShares funds.

ETFs are funds that trade on an exchange like a stock. They are an easy to use, low-cost way to invest money and are widely available on most online brokerage accounts and through financial advisers. Click here for more on How to buy ETFs.

ETF Risks

Although ETFs offer many benefits, they are not risk-free. Like all investments, ETFs involve market risk and may lose value.

ETF risks depend largely on the underlying investments. Equity ETFs may experience stock market volatility, while bond ETFs can be affected by interest rates and credit risk.

Here are some of the additional risks ETF investors should be aware of:

Market Volatility: ETF prices fluctuate as underlying investments rise and fall.

Periods of market stress can create significant short-term losses.

Overconcentration: Investing heavily in one sector, country, or theme may increase portfolio risk. Diversification may help mitigate concentration risk.

Performance Chasing: Buying investments solely because they recently performed well may increase the likelihood of disappointment. Past performance does not guarantee future results.

Leveraged ETFs: Leveraged ETFs are normally considered higher risk and seek amplified daily returns and may not be appropriate for all investors. Leveraged ETFs are generally designed for short‑term trading and may not be appropriate for long‑term or inexperienced investors. Their performance over longer periods can differ significantly from investor expectations.

Emotional Investing: Reacting to headlines and market volatility may lead investors to abandon long-term plans. Learn more about emotional investing and other common mistakes investors make.

Trading Too Frequently: Frequent trading can increase costs and potentially undermine long-term results.

Investors seeking additional education on understanding investment risk may benefit from evaluating how risk tolerance affects asset allocation decisions.
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Why consider iShares ETFs?

Whether you’re dipping your toes into ETFs or fine-tuning your portfolio, iShares has 1700+ ETFs globally, and over 50 ETFs listed in Australia. Our broad range of ETFs are designed to help you express your investment views and build a portfolio that fits your needs.

Frequently asked questions about ETF basics

An ETF is a simple way to invest in many companies or bonds at once. Instead of buying shares in lots of individual companies – or buying multiple different bonds – you could buy a single ETF that bundles them together for you.

ETFs are designed to track market indices, such as the ASX 200 or S&P 500, or sectors like technology or energy. Some are actively managed to pursue goals like outperforming a benchmark, generating income, or managing risk. ETFs provide investors with a simple way to access financial markets without having to buy individual stocks, bonds or other asset classes separately.

Say you invest in an ETF that tracks an index like the FTSE 100, which represents the 100 companies with the highest market capitalisation (total market value of their shares) listed on the London Stock Exchange. You’re investing in a bit of every company in the index with a single trade – rather than having to buy a share in each company individually.

ETFs can be based on asset classes like stocks, bonds and commodities. There are ETFs for particular countries or continents, and you can also find plenty that are based on industries and trends such as clean energy or healthcare innovation. So, no matter what you want to invest in, you’ll find an ETF that suits you.

Investing in ETFs can be an affordable way to access global financial markets, but there are different costs to consider, which may vary from provider to provider. Broadly, those costs fall into two main categories: ongoing and transaction.

Ongoing costs are the fees that investors pay to the ETF provider to manage and operate the fund. Often called expense ratios, these costs are usually expressed as a percentage of the fund's net asset value and are deducted from the fund's gross returns. The lower the expense ratio, the less your investment is spent on administrative fees and other operating costs. The ongoing costs are usually disclosed in the fund's fact sheet or product page.

Transaction costs are fees and expenses that investors pay to the bank or broker when they buy or sell ETFs. These vary on the provider and are often called commissions or exchange fees.

First, decide which region or industry you’d like to invest in. For example, if you want to invest in Australia, you could pick an ETF that tracks an index made up of Australia companies like the ASX 200. Or, if you want to be more selective, you could invest in just one industry, like tech or healthcare.

Investing always involves some level of risk, and ETFs are no exception. Here are some of the risks you should be aware of before you invest in ETFs:

Market risk

ETFs are subject to market fluctuations. The value of investments and the income from them may go down as well as up and you may not get back the amount you originally invested.

Concentration risk

Investment risk is concentrated in specific industries, countries, currencies or companies. As a result, certain funds are more sensitive to local economic, market, political or regulatory events.

Currency risk

International ETFs sometimes invest a large proportion in values denominated in a foreign currency. Therefore, changes in the applicable exchange rate will affect the value of the relevant fund shares and your investment exposure.