WTF is an ETF?
28 May 2021
The world of finance can sometimes seem to speak another language. For every basic investment term there are loads of jargon-heavy acronyms.
‘ETF’ is one of those acronyms that you’re going to see time and time again in your investing journey. In this blog we explain what an ETF is and why people invest in them.
‘E’ stands for ‘exchange’
First of all, let’s get some definitions out of the way. ETF stands for “exchange-traded fund.” Let’s start with the first letter: E for “exchange.”
When you invest in shares or bonds on the Sharesies platform, you usually buy them from someone else on an exchange (like the Australian Stock Exchange, a.k.a. the ASX). For example, if you bought a share in Westpac, you would own a piece of Westpac. If you bought a bond issued by Westpac, you would be owed money by Westpac. You can buy shares or bonds from someone else on an exchange, and you can also sell your shares or bonds to someone else.
‘F’ stands for ‘fund’
Buying and selling things on exchanges is different from another way of investing - investing in managed funds. When you invest in a managed fund, you hand your money over to a fund manager, and they invest it on your behalf. In this situation, you don’t buy or sell on the exchange - the fund does instead.
Superannuation funds are good examples of this approach. You give your superannuation money to a fund manager, who pools it together with lots of other peoples’ superannuation money, then invests it on your behalf.
Funds—but on an exchange
Now that we understand both of these concepts, we can add them together to talk about ETFs.
An ETF has some similarities to a managed fund. When you invest in an ETF, you are taking your money and splitting it across lots of different investments, rather than just one single share, bond, or something else. For example, the S&P ASX200 ETF splits the money you invest across 200 different investments listed on the ASX. This means that ETFs can often be a good way to diversify your portfolio across different industries as well!
One big difference between ETFs and managed funds is that ETFs trade on the exchange. You don’t hand your money over to a fund manager when you invest in ETFs. Rather, you own a share of a company whose sole purpose is to track another set of investments (like the S&P ASX200 ETF example we mentioned a minute ago).
Therefore, investing in an ETF means your money gets invested in lots of different things.
What are the benefits?
Here are some of the reasons people invest in ETFs.
You may have heard the saying ‘don’t put all your eggs in one basket’. When you invest in an ETF you’re investing in a range of assets, instead of shares in just one company.
Since ETFs are traded on exchanges, and you can own portions of shares, there’s more accessibility for investors to buy into ETFs. On the Sharesies platform, you can invest from as little as 1¢ so investing in ETFs through Sharesies can be more accessible than investing in managed funds through other avenues that have minimum investment requirements.
ETFs on Sharesies have a transaction fee on each order. However, since there’s no advisor hanging onto your money and making decisions, ETFs might have lower fees than other types of investments, like managed funds.
The market price of an ETF unit is updated throughout the exchange opening hours so you can see the price you’re buying or selling at. Managed funds report their unit prices for each trading day retrospectively.
Orders on the Sharesies platform may be subject to our Best Price Policy (NZX orders) or our partners’ regulatory obligations and ‘best execution’ policies.
Since ETFs are on an exchange, it’s usually easy to change your shares into cash, by selling to someone else.
A fruity example 🍒
Imagine you go to a market (ASX) and buy some fruit. Buying individual fruit is like buying individual company shares. You pay the price for each piece of fruit.
An ETF is like buying a basket of fruit. You get all the different types. These can be grouped by theme, like a colour or a season.
If you just buy a bag of apples, and they go off, then you have nothing. But if you diversify by buying a basket of fruit featuring a mix of fruit—apples, bananas, and pineapples—and the apples go off (or decrease in value), you still have lots of other fruit to munch on. ETFs offer a similar approach with a diversified mix of shares, so if one share decreases in value, other shares could be performing differently (i.e. going up, down, or staying stable).
Now that you know how ETFs work, you can take a look at whether they make sense for your portfolio and within your broader investing strategy. Do your due diligence as well: you can check the product disclosure statement (PDS) before you invest.
A PDS contains a lot of information you'll need to know about an ETF. It includes information on:
what index, sector, or asset the ETF returns aims to replicate
the fees and costs
the risks of investing in the ETF
how to complain if you have a problem with the ETF.
If you have questions about an ETF you can contact the fund manager or get financial advice. You can also check recent market announcements for new information on an ETF.
Ok, now for the legal bit
Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written. You should consider seeking independent legal, financial, taxation or other advice when considering whether an investment is appropriate for your objectives, financial situation or needs.