What is an ETF?
ETFs have gained a mass following over the past few years and only seem to become more and more popular. But what are they?
ETFs are funds that trade ‘on-exchange’. They track sectors or indices and as they are traded on exchange, trade just like your usual stocks and shares.
What Does ETF stand for?
ETF is an acronym for Exchange-Traded Fund.
What does Exchange-Traded mean?
Well, the clues in the name – It simply means that the fund in question is traded on an exchange as opposed to ‘Off-Exchange’. Think of an asset like a FTSE stock. These stocks are traded on the London Stock Exchange and therefore they are traded, on Exchange.
What is an example of an asset that’s traded off exchange?
Off exchange trading, or OTC trading (Over the Counter) is when an asset isn’t traded on an exchange. The best example for an OTC product would be the Spot FX market as it is the world’s largest OTC market!
How Risky are ETFs?
Well that all depends on the fund you choose to invest in! Much like stocks, there are completely varying levels of risk associated with different funds.
Do ETF holders own the underlying assets in the fund?
No they don’t. Why? Let’s take a look at the way an Exchange traded funds work, to fully understand why. The Fund Managers/Providers own the underlying assets of the fund. They choose which assets make up the fund and make the purchases that make up the structure of said fund.
Then, once their fund is complete and performance can be tracked, they will sell a portion of shares of the fund itself, to the investors.
Are ETFs only made up of stocks?
No – Other examples of holding within an ETF are FX holdings, Commodities and Bonds.
How do I invest in ETFs?
Whilst the term ‘Exchange Traded Fund’ may sound fairly complex – It’s an extremely easy process to start investing and trading in them. Many brokers these days allow you to trade them freely on their online platforms, whether that be MT4 or a proprietary platform.
As the popularity of retail online trading has spiked in recent years, the offerings of MT4 brokers as well as web-based and prop trading providers has also followed suit. You can trade in a plethora of Exchange Traded Funds with the click of a button these days!
What are the benefits of trading ETFs?
The main benefits of trading Exchange traded funds are as follows:
- Costs of ETFs – are typically lower than other types of mutual funds
- Tax purposes – You only have to pay tax when the fund holding is sold (We are not tax advisers – so please seek independent tax advice if you have further queries on this subject)
- Diversification – As previously mentioned, Exchange traded funds can contain many different asset types and multiple holdings of the same asset. For this reason, the fund managers can diversify each holding, so all your eggs aren’t in one basket
- Dividends – not only can you earn from the underlying stock purchases in your fund, but these dividends can be automatically re-invested
- Transparent – Information on exchange traded funds is very easy to come across. You can track the prices real-time online or on your trading platform. You can look up the holdings of each fund immediately. This differs from traditional funds where this information is harder to come by and price checks are on an intermittent (end of day) basis
Can I go short on ETFs?
Yes you can. This is an added benefit of exchange traded funds. You can short them just like you can short stocks. Not only can you short Exchange traded funds – There are actually funds out there that are specifically designed to short stocks themselves – These are known as ‘Inverse ETFs’.
What are the 5 largest ETF Firms?
- State Street SPDR – 750B AUM
Fund example:
AUM – $316.3 billion
This fund started back in 1993 by State Street Global Advisors Trust Company. Its trades in USD on the NYSE and it is benchmarked against the S&P500.
- IShares – 1.8T AUM
Fund example:
AUM – $217.9 billion
IShares Core S&P500 is another exchange traded fund benchmarked against the S&P500. Its inception date was May 2000 and it’s also traded in USD on the NYSE.
- Invesco – 260B AUM
Fund example:
AUM – $94.5B
This fund was formed in 1999. It tracks the performance of the Nasdaq-100 Index. Its traded in USD on the Nasdaq exchange and has consistently outperformed the S&P500 index in recent years.
- Charles Schwab – 175B AUM
Fund example:
AUM – $4.2B
This fund was formed back in November 2009 and tracks the performance of the Dow Jones US Large Cap Total Stock Market Index.
- Vanguard – 1.4T AUM
Fund example:
Vanguard Total Stock Market ETF (VTI)
AUM – $145.4 billion
The Vanguard Total Stock Market fund tries to track and replicate the performance of the entire US equity market.
What is an ETF: Final Thoughts
- ETFs are great vehicles of investments for investors looking for diversification, transparency and lower costs than traditional forms of fund investment
- There can be tax advantages when trading ETFs especially when it comes to CGT (Capital gains tax) but as previously mentioned its always best to do your own research when it comes to taxation
- ETFs make it possible for the everyday investor to reach many different sectors, industries, investments and countries that they may not have been able to reach without the ETF vehicle
- ETFs are now easily trade-able on most online trading platforms, including MT4 and as time goes by, there seems to be more and more options when it comes to Exchange traded funds
- As ETFs are traded ‘on exchange’ the liquidity (How easy it easy to buy and sell your holdings) is high. This is particularly important to many traders and investors in todays marketplace.
- And Finally, as we previously mentioned, dividends can be automatically reinvested and in some cases dividends will drop into your account on a quarterly basis.
We hope you have found this article helpful and if you’re ready to start trading and/or investing in ETFs – Please click here to open your account today.
Good Luck and Happy Trading!
