ETFsEXPLAINED.

Exchange-traded funds (ETFs) are an easy way to invest. A way that tends to have low upfront cost, that is flexible yet also simple, transparent and easy to trade. Learn what ETFs are and how they can make your money do more for you minus the relative complexity of many traditional investment products.

ETFs Explained
What is an ETF?
2 min

What is an ETF?

What is an ETF?:share:Open Modal
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ETFs are investment funds that track the performance of a specific index – like the Hang Seng Index or S&P 500. Just like stocks, you can trade ETFs on a stock exchange at any point during market hours. Whether you’re an individual looking to invest, or a seasoned financial professional, ETFs are an easy and powerful investment option to help meet your goals.

ETFs are similar to trading stocks…

Trading stocks is second nature for most investors. You can trade stocks yourself or find a broker to help. Trading ETFs is no different from trading stocks, and a little research goes a long way to helping you choose the right ETF.

How do ETFs compare to managed funds?

Managed funds (also known as mutual funds) are investment products that pool together money from a range of investors. A fund manager then actively manages and invests this money into a basket of different assets and securities – often stocks. You pay the manager in the hope they drive better performance than the market performance.

While managed funds may offer good returns, in most cases you can’t buy and sell them whenever you want. ETFs however, act similarly to stocks so you can buy and sell them anytime during market hours.

How do ETFs compare to managed funds?

ETFs give you the best of both worlds

Like managed funds, ETFs are a basket of stocks, bonds or other assets, but overall there’s lots of key differences. ETFs combine certain key features of stocks and managed funds.

  • ETFs are more diverse than investing in individual stocks. Instead of buying a handful of individual stocks, investing in an ETF would give you instant exposure to a multitude of stocks.
  • Unlike a managed fund, an ETF does not aim to beat the index, but to match its performance, giving you potentially more predictable returns.
  • Managed fund managers often charge you more to pick investments to outperform an index or benchmark, but since ETFs generally track the index, it is usually lower cost compared to a managed fund.
  • Managed fund managers often charge you more to pick investments to outperform an index or benchmark.
  • ETFs give you flexibility in allowing you to enter and exit at any time.

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Advantages of ETFs
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Advantages of ETFs

Choosing the right investment is like choosing a new car. You want a safe option that is good value and reliable, and something that suits your needs. We will explore some advantages of ETFs and reasons why they are a great way to invest, including transparency, index performance, access, liquidity and diversification.

ETFs diversify your investment and lower risk

With one simple trade, buying an ETF gives you instant diversification. It’s important to think about diversification if you want to reduce risk while maximising returns. ETFs offer investors greater diversity than simply buying individual stocks1.

ETFs match index performance

Investments are never guaranteed but ETFs track indexes to help take the guess work out of investing. There are no surprises because you know a good ETF will aim to closely match the performance of the underlying index that it invests in.

ETFs are transparent so you know what you are getting

Generally, ETFs are transparent, because you can always see what the underlying investments in the ETF are. This is not always the case, for example in a managed fund, where the portfolio manager has the discretion to choose not to reveal the investments in the fund.

ETFs make accessing markets easy

There is usually an ETF for whatever you are looking to invest in, from a country in southeast Asia to an asset class like global bonds—and even commodities like gold. For investors who would like to invest in difficult-to-access markets such as emerging markets, it now becomes straight forward by investing into an ETF.

ETFs are easy to trade

Since ETFs trade on the exchange, you simply buy and sell your ETF via your broker, at the market price., with no minimum purchase requirement.

Bonus: The annual management expenses for ETFs are typically lower than those of managed funds2!

In summary, ETFs are the better way to invest because...

They’re low cost.
And usually much cheaper than mutual funds.

You know what you’re getting.
They’re transparent and you can see the underlying investments.

They offer the best of both worlds.
The diversification of a managed fund with the tradability of a stock.

There are no surprises.
You know a good ETF will aim to closely track the performance of the underlying index it invests in.

They make accessing markets easy.
With one trade you get exposure to a whole range of assets.

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Risks of ETFs
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Risks of ETFs

We’ve talked about the advantages of ETFs, but let’s not forget that all investments come with risk. To put it simply, risk affects the value of your investment. More risk can mean more reward but less certainty around the outcome. For every investment decision, you need to be aware of and comfortable with the level of risk to take. We will take you through some of the ways you can prepare for risk when looking at ETFs.

Can you prepare for risk?

The value of your investments can be affected by several things such as stock market movements, political and economic news, company earnings and major corporate incidents. While many of these you may not be able to predict or plan for, a better understanding of your investment choices can potentially minimize the effect of these risks.

What risks should you be wary of?

Capital risk: All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

Tax risks: International taxes will impact your return. Do your research to assess how much your ETF returns may be taxed.

Currency risks: ETFs feature some level of currency risks. International ETFs are priced in local currencies, so changes in exchange rate will impact the value of your investment.

Liquidity risk: Liquidity is the ability to turn an investment into ready cash quickly, with no loss in value. Low liquidity of an ETF s can lead to higher trading costs or difficulty in buying or selling the ETF. For a regular investor to assess liquidity, you should look at statistics such as:

  1. Average bid/ask spreads which is the difference between the buy and sell price of the ETF. In general, the narrower the spread, the more liquid an ETF is.
  2. Average trading volume. In general, the higher the volume, the more liquid an ETF is
  3. Whether the ETF is trading close to its net asset value, an indication of the fair value of each ETF share the closer it is, the more liquid the ETF is.

If you are an investor who is trading a large quantity of shares at once, the liquidity of the ETF’s underlying securities is the more important factor.

Reducing the risk

You can’t eliminate risk completely but you can reduce it in many ways. Diversification is one of the ways you can do so, by spreading your investments across different sectors, geographies and asset classes. If one sector or asset isn’t performing well, other investments can balance out any potential loss.

However, it is important to note that diversification may not fully protect you from market risk and does not guarantee returns or eliminate potential for loss, so do your research carefully!

Know before you invest…

Before making any investment decisions, it’s important you fully understand the risks involved. Do your research, consult the fund’s offering documents, or talk to a financial advisor to help you make the best choice.

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Busting the Five Myths of ETFs

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When things are hyped like ETFs have in recent years, there are often misunderstandings and a few false truths. Let’s be clear on what ETFs really are and what they are not.

Myth 1: ETFs are volatile because they are traded throughout the day.

Reality: ETF prices are transparent, but that doesn’t make them more volatile.

The price of an ETF reflects the changing value of its underlying securities and the supply and demand of the ETF in the marketplace. The difference between an ETF and an actively managed fund is that the price of a managed fund, which similarly reflects the value of its underlying securities, is fixed once a day and only after the market closes, while ETF pricing changes throughout the day in real time. This doesn’t mean that ETFs are more volatile – their price changes are just more visible.

Myth 2: ETFs are inherently risky.

Reality: Risk is driven by the assets you're investing in, not necessarily the vehicle used to access the assets.

Just like a managed fund, the risk profile of an ETF is tied to its underlying holdings, or the assets it invests in: so a managed fund and ETF that hold similar stocks or bonds will have similar risk profiles. For example, an international stock ETF or managed fund may have higher risks than a U.S. investment grade corporate bond ETF. But that risk is not related to whether you choose to hold a managed fund or an ETF.

On the flip side, an ETF offers greater diversification than an individual stock, which may help reduce risk in a portfolio3.

Myth 3: ETFs only apply if you’re investing in a very specific piece of the market.

Reality: You can use ETFs for a wide range of exposures and outcomes.

ETFs come in virtually any “flavor” you can think of. They offer low-cost access to specific markets (e.g., a country or industry), AND to broad exposures (e.g., the Hang Seng, STI or the U.S. bond market). This, combined with the ease and speed with which they can usually be bought and sold, means that investors can access investments that may otherwise be out of reach.

So whether it’s hard-to-access foreign markets, core building blocks for your portfolio, or funds that target specific outcomes, there’s an ETF that can help.

Myth 4: ETFs aren’t for income investors since they don’t pay dividends.

Reality: iShares ETFs offer a diverse set of solutions for investors looking for income.

The hunt for income in the low interest rate environment can be challenging. But whether it’s through dividend-paying stocks or fixed income exposures, ETFs offer investors a broad range of opportunities to potentially generate income. And with ETFs, you get the added benefit of greater diversification than an individual stock or bond, all typically at a lower cost than a managed fund.

Myth 5: ETFs are just for day traders.

Reality: ETFs are effective investment tools for many types of investors

Because ETFs have the same trading flexibility as stocks, short-term traders can use ETFs to quickly move in and out of a position. But ETFs are also a cost-efficient way to build a long-term, core portfolio. In fact, almost 80% of ETF investors view them as long-term holdings with an average holding period of nearly 6 years4.

Points to take away

Now that you’ve got the ETF basics, here’s a recap of what you should keep in mind:

  1. ETFs are simple, low cost, transparent, and also offer diversity and flexibility
  2. ETFs offer the best of managed funds and individual stocks
  3. ETFs can meet the needs of income investors, day traders, in fact all types of investors

Sources

  1. Diversification does not fully protect you from market risk and does not guarantee returns or eliminate potential for loss.
  2. Morningstar, as of 12/31/18. Comparison is between the average Prospectus Net Expense Ratio for the iShares ETFs (0.34%) and active open-end mutual funds (0.96%).
  3. Diversification does not fully protect you from market risk and does not guarantee returns or eliminate potential for loss.
  4. Source: 2018 BlackRock ETF Pulse Survey, conducted from August 22nd through September 3rd, 2017 by Market Strategies International, an independent research company. The survey interviewed over 1,000 individual investors from nationally representative online samples of household financial savings/investment decision makers age 21-75, with $100K+ in investible assets and aware of ETFs in the US.
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ETFs explained

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