ETFs 101: What They Are and How to Invest

ETFs, or exchange-traded funds, are a type of investment vehicle that allows you to diversify your portfolio with a single trade.

They're similar to mutual funds but trade on an exchange like stocks, making them highly liquid and flexible.

ETFs can track a broad market index, sector, or even a specific asset class, giving you exposure to a wide range of investments.

You can buy and sell ETFs throughout the trading day, allowing you to react quickly to market changes.

Some ETFs are designed to track a specific sector or industry, such as technology or healthcare.

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ETFs are investment funds that hold multiple underlying assets and can be bought and sold on an exchange, much like an individual stock.

You can buy and sell ETFs on an exchange, which makes them a convenient option for investors.

ETFs can be structured to track anything from the price of a commodity to a large and diverse collection of stocks.

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The first ETF in the U.S. was the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index.

ETFs can be designed to track specific investment strategies, giving investors a range of options to choose from.

ETFs can be used for income generation, speculation, or hedging risk in an investor's portfolio.

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ETFs are a type of investment that can be a great addition to your portfolio. They're essentially a fund that contains many investments, such as stocks and bonds, organized around a specific strategy or theme.

An ETF can track a sector of the stock market, like technology or energy, or it can invest in a specific type of bond, like high-yield or municipal.

ETFs trade on exchanges like stocks, and their price changes throughout the day, providing liquidity and flexibility.

Here are some key characteristics of ETFs:

ETFs have become popular with investors because they offer a simple way to buy a diversified investment, like an index ETF.

An ETF is registered with the Securities and Exchange Commission (SEC) and is subject to the Investment Company Act of 1940. Most ETFs are open-ended funds that don't limit the number of investors involved in the product.

Investors buy a share of the fund, which owns the shares of the underlying companies. This means there's no transfer of ownership, unlike mutual funds which trade only once a day after the markets close. ETF share prices are determined throughout the day.

ETFs can be bought and sold on an exchange, like the Australian Securities Exchange (ASX) or Cboe Australia (CXA), and units can be created or redeemed to match investor demand. This helps the price of the units to stay close to the net asset value (NAV) of the ETF.

ETFs track a specific index or asset, such as the S&P 500 or gold, and the value of the ETF goes up or down with the index or asset it's tracking. The role of the fund manager is to track the value of the index or asset, not to try to outperform the market.

ETFs work through a process of creation and redemption, where authorized participants buy or sell the underlying assets to create or redeem new ETF shares. This process occurs in large blocks called creation units, often equalling 50,000 shares of the ETF.

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ETFs are a type of investment fund that can be bought and sold on an exchange, like individual stocks. They hold multiple underlying assets, such as stocks, bonds, or commodities, and can track a specific index, commodity, or investment strategy.

An ETF provider owns the underlying assets and designs a fund to track their performance, then sells shares in that fund to investors. Shareholders own a portion of the ETF, but they don't own the underlying assets.

ETFs can be structured to track anything from the price of a commodity to a large and diverse collection of stocks. They can even be designed to track specific investment strategies, such as income generation, speculation, or hedging risk.

To create new ETF shares, an authorized participant gives the ETF a basket of assets that match the ETF's portfolio or a cash payment. In exchange, they receive a block of new ETF shares with the same value as this creation basket. This process occurs in large blocks called creation units, often equalling 50,000 shares of the ETF.

ETFs involve a process of creation/redemption, which is the lifeblood of these types of securities. This process works as follows:Large institutional investors, known as Authorized Participants (APs), create or redeem new shares of an ETF by transacting with the ETF manager.The ETF manager communicates which shares it wants to own in the fund, known as the creation basket.The APs go to the market and buy the stocks in the creation basket in the right percentages, or uses the shares it holds, and delivers this representative basket of securities to the ETF for an equal amount (value) in shares of the ETF.

The price of the ETF is determined by market forces, and it can trade at a price that differs from the underlying assets. The creation/redemption process exerts downward pressure on the price of the ETF and upward pressure on the price of the underlying stocks, until no further arbitrage can be made.

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Physically-backed and synthetic ETFs are two distinct types.

Physically-backed ETFs invest in all the securities in the index or a sample of the securities in the index. This means they hold the actual assets that make up the index, providing a direct connection to the underlying investments.

Synthetic ETFs, on the other hand, hold some of the underlying assets and use derivatives to copy the movements of an index or asset. This type of ETF may use the word 'synthetic' in its name, indicating its use of derivatives.

Synthetic ETFs have an additional risk that the counterparty to the derivative could fail. This risk is not present in physically-backed ETFs.

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ETFs offer a wide range of investment options, making them a versatile choice for investors.

You can invest in various asset classes, including Australian shares, international shares, sectors of the Australian or international share market, fixed income investments like bonds, precious metals and commodities, foreign currencies, crypto assets, and diversified across multiple asset classes.

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Some popular types of ETFs include index ETFs, which track a market index like the S&P 500, and actively managed ETFs, which are funds managed by a team of professionals to potentially outperform passively managed funds.

ETFs can also be categorized by the types of investments held within the ETF, such as stock ETFs, bond ETFs, commodity ETFs, currency ETFs, and inverse ETFs.

Here are some common types of ETFs:

There are many types of Exchange-Traded Funds (ETFs) to choose from, each with its own unique characteristics and benefits.

ETFs can be categorized by their underlying assets, such as commodities, bonds, stocks, or currencies. They can also be structured to track specific investment strategies or sectors of the market.

Some ETFs hold physical commodities like gold, coffee, or crude oil. Commodity ETFs can be a great way to diversify your portfolio and hedge against inflation.

Actively managed ETFs, on the other hand, are handled by a manager or investment team that decides the allocation of portfolio assets. These ETFs have higher portfolio turnover rates compared to index funds.

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Leveraged ETFs offer the ability to amplify gains by using financial derivatives. However, they are typically used by traders who are speculators looking to take advantage of short-term trading opportunities.

Sector ETFs provide a way to invest in specific companies within a particular sector, such as health care, finance, or technology. These can be especially useful for investors tracking business cycles.

Here are some common types of ETFs:

ETFs can be a great way to diversify your portfolio and achieve your investment goals. With so many types to choose from, it's essential to understand the characteristics and benefits of each before making a decision.

Active hedge funds are actively managed investments that use high risk trading strategies to try to outperform an index.

These funds are designed to take advantage of market fluctuations and make quick decisions to maximize returns.

Investment managers may use complex strategies to try to beat the market, but this can also lead to significant losses if things don't go as planned.

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Active hedge funds often use leverage, which means they borrow money to invest in more assets, potentially increasing returns but also amplifying losses.

Investors should be aware that active hedge funds are not for the faint of heart, and it's essential to thoroughly research and understand the risks involved before investing.

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You can trade ETFs through online brokers and traditional broker-dealers. Many sources provide pre-screened brokers in the ETF industry.

To get started, you'll need to create and fund a brokerage account, which will allow you to search for and buy ETFs. Most brokerage accounts offer commission-free trading, meaning you won't have to pay fees to the platform providers to buy or sell ETFs.

Before investing in an ETF, research the fund's objective and strategy, and investigate what the fund invests in. This will help you understand how the investment fits into your overall investing plan and asset allocation strategy.

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Investing in ETFs can be a savvy move, especially when you consider the lower fees involved. With an expense ratio of 0.18% on a $1,000 investment, you're only paying $1.80 in fees a year.

ETFs are listed on public exchanges, making it easy to buy and sell them throughout market hours. You can even see their prices change in real-time, giving you a clear picture of the market.

One of the most significant advantages of ETFs is their tax efficiency. Unlike mutual funds, ETFs help shareholders reduce annual taxes on their holdings, typically only realizing a gain or loss when you sell shares.

ETFs are also highly liquid, allowing you to buy or sell them throughout the day. This liquidity is a major advantage over mutual funds, which can only be bought or sold at their end-of-day closing price.

With ETFs, you have access to a wide range of markets, including emerging markets equities and bonds, gold bullion, and cryptocurrencies. This exposure can be a valuable addition to your investment portfolio.

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To invest in ETFs, you'll need to open a brokerage account. Many brokerage accounts allow you to trade ETFs, and some retirement accounts, like IRAs, do too.

Before opening an account, look into the trading capabilities of the brokerage or financial institution, and see if the financial institution charges any trading commissions or fees. Once you have an account, you'll have to deposit money in it to start investing in ETFs.

You can search for ETFs and buy and sell as wanted after creating and funding a brokerage account. Most online investing platforms, retirement account provider sites, and investing apps like Robinhood offer commission-free trading.

To narrow ETF options, utilize an ETF screening tool with criteria such as trading volume, expense ratio, past performance, holdings, and commission costs. This will help you find the right ETFs for your portfolio.

Here are some key things to research before investing in an ETF:

Read a fund's objective and strategy thoroughly, and investigate what a fund invests in. Research the fund's expense ratio, and make sure it aligns with your investment goals, risk tolerance, and time horizon.

ETFs offer lower investment costs compared to other investments. This is one of the key benefits that set them apart.

ETFs provide better diversification than stocks, giving you a more stable investment option. You can spread your risk across various assets with ETFs.

ETFs have an increasing number of options available, making it easier to find the right investment for you. This is a significant advantage over mutual funds, which have limited choices.

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Index funds and ETFs are often compared, but they have distinct differences. An index fund is a mutual fund that tracks an index, while an index ETF is a type of exchange-traded fund that also tracks an index.

An index ETF is more cost-effective and liquid than an index mutual fund. You can buy an ETF throughout the trading day, while a mutual fund trades via a broker after the close of each trading day.

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ETFs tend to have lower expense ratios than mutual funds, with some ETFs having expense ratios as low as 0.05%. This is because ETFs are traded on an exchange, which means that the costs are typically borne by the broker or the exchange, rather than the fund itself.

Here are some key differences between index funds and ETFs:

ETFs are generally more transparent than mutual funds, with daily disclosure of their portfolios. This allows investors to track how their money is being invested and make informed decisions.

When comparing the price of an ETF to its Net Asset Value (NAV), it's essential to understand how they're calculated. The NAV is calculated by taking the assets of the fund, subtracting the liabilities and dividing this by the number of units in the fund at the end of the day.

You can check if an ETF is fairly priced by comparing its price on the ASX or Cboe with the NAV or the indicative or intraday NAV (iNAV). The iNAV is a real-time estimate of the NAV, published during the day.

ETF providers give updates of the NAV on the ASX at the end of the day and generally on the ETF provider's website. The price to buy and sell an ETF should be close to the NAV per unit. However, at times, such as on days with large changes in prices of the asset classes, the price of the ETF may move away from the NAV.

You can use the iNAV as a reference point during the day to understand if an ETF you're buying or selling is at, or close to, the NAV per unit. To get the latest iNAV, you can add 'Y' before the ETF ticker, for example 'YABCD' for the ETF ticker 'ABCD'.

Here's a comparison of NAV and iNAV updates:

This comparison can help you make informed decisions about buying or selling an ETF.

Mutual funds are pooled investments into bonds, securities, and other instruments. They can be bought and sold only at the end of a trading day.

Mutual funds own the securities in their basket, which can span multiple asset classes, sectors, industries, and security instruments. This diversification can help reduce risk.

Some mutual funds do not charge load fees, but most are more expensive than ETFs because they charge management fees. The average equity fund expense ratio is 0.42%, plus any additional fees.

A key difference between mutual funds and stocks is that mutual funds trade at the net asset value of the overall fund, whereas stocks are traded during regular market hours based on their actual performance in the markets.

Here's a comparison of mutual funds and stocks in a table:

ETFs are a cost-effective way to invest in the market, with many options available to suit different budgets. Some ETFs have share prices ranging from the single digits to the triple digits, so it's essential to outline how much you're willing to spend before diving in.

ETFs are generally passively managed, which means their expense ratios are typically low. In fact, ETF expense ratios are often lower compared to other types of funds.

If you're looking for a specific type of ETF, be aware that some may have a larger bid-ask spread due to low trading volume. This can result in a larger discount on your sale or a premium on your buy.

Here are some key ETF fees to keep in mind:

ETFs are also more tax-efficient than mutual funds because most buying and selling occur through an exchange, and the ETF sponsor doesn't need to redeem shares each time an investor sells. This can save you money on taxes in the long run.

Trading costs can be a significant disadvantage of ETFs, with commissions or fees associated with buying or selling from certain financial institutions.

A large bid-ask spread can also eat into your profits, as it can mean you'd have to take a discount on your sale or pay a premium on your buy.

You can't get a say in what ETFs invest in, which can be a drawback if you're not comfortable with the securities they hold.

This means you need to make sure you're committed to gaining exposure to all those securities before investing in a given fund.

Tracking errors can also occur with passive ETFs that aim to track market indexes and indicators, leading to a discrepancy between the ETF's performance and the benchmark's price changes.

Investing in an ETF with a poor tracking record can be a costly mistake, so it's essential to investigate its track record before investing.

ETFs can vary significantly in cost, with share prices ranging from the single digits to the triple digits, making it crucial to outline how much you're willing to spend before investing.

The fund's expense ratio, or the fee the fund charges to manage and maintain it, is also an essential consideration when researching ETFs.

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ETF investors can benefit from companies that pay dividends, which are a portion of earnings allocated to investors.

Dividends are a share of earned interest or dividends, and ETF shareholders may also get a residual value if the fund is liquidated.

An ETF is more tax-efficient than a mutual fund because most buying and selling occur through an exchange.

This means the ETF sponsor doesn't need to redeem shares each time an investor wishes to sell shares of the ETF.

In contrast, mutual funds incur a tax liability when an investor sells their shares, which must be paid by the shareholders of the fund.

For example, if you sell your shares in a mutual fund, you'll be hit with a tax bill that can eat into your returns.

But with ETFs, this tax burden is significantly reduced.

Here's a comparison of the tax efficiency of ETFs and mutual funds: