How to invest in ETFs

If you’ve been within an inch of a conversation about investing in the last few years, you might’ve heard the term ‘exchange-traded funds’ thrown about. 

Exchange-traded funds (ETFs) have been growing in popularity since these investment products first hit the market in the 1990s.  

They’re touted as being great for beginners who are trying to build up their portfolios, because they often charge low fees, require little time or maintenance, and might provide in-built diversification, which could lower your overall risk.  

But, if you’re new to the world of investing or have typically only traded stocks, you might be wondering what ETFs are and how to invest in them. So, we’ve put together a comprehensive guide on ETFs for beginners, which aims to clear some of the confusion around this sort of investment.

ETFs are managed funds that pool money from a group of investors to buy assets like shares, cash, bonds, and property trusts that are listed on an exchange, like the ASX200. 

They’re usually managed by a fund manager, who could be an individual or organisation that is responsible for investing funds on behalf of investors. 

ETFs are passive investments which aim to replicate the performance of an index or exchange over the long-term. 

What types of ETFs are there?

There are two types of ETFs, according to Moneysmart :

• Physically-backed ETFs. Invests in either all the securities (like shares and bonds) in an index, or a selection (sample) of the securities in an index.
• Synthetic ETFs. Aims to replicate the performance of an index or asset via swap agreements, which are when a counterparty (like a bank) agrees to pay the difference between the ETF’s asset value and the value of the assets or index it is designed to track. They’re considered higher-risk than physically-backed ETFs. 
  

Are ETFs high risk?

ETFs are typically considered low-risk investments when compared to directly investing in shares of a single company.

This is due to their long-term, low-cost nature, and their innate diversification.

However, investing in ETFs doesn't come without risk entirely and certain ETFs are riskier than others. 

If you're considering investing in ETFs, you should carefully consider the risks involved, do your research, and, as always, read the product disclosure statement (PDS) before you make your choice. 

As mentioned above, ETFs are often classified as a passive investment, meaning that the aim of the game is to build your investment over the long-term. Not quite set-and-forget, rather, buy-and-hold. They do this by aiming to match the performance of a given market. 

For example, if your ETFs are in the ASX200 and the exchange is doing well, then your investment should grow in line with the market. Conversely, if the ASX200 is falling, like during the GFC or the beginning of the pandemic, then the value of your investment will likely plummet too. 

However, it should be noted that when you invest in an ETF, you don’t actually own the underlying investments. You own units in the ETF, rather than the individual shares or assets, which are owned by the ETF provider. You’re essentially investing in the fund manager’s ability to track the market. 

How ETFs track an index or exchange 

A lot of ETFs are passively managed, which means that they track a market like the ASX200 and don’t actively attempt to beat the market.  

With some ETFs, individual investments aren’t actually selected by a human fund manager. Instead, they could be selected based on algorithms to track the performance of an exchange.

This means that ETFs can change holdings over their life cycle, with the explicit aim of improving the overall quality of the fund. But if and how often a fund’s holdings change is largely based on what the fund tracks. 

For example, if you invest in an ETF which tracks the whole ASX200, then the fund’s holdings will likely change quarterly, when companies listed on the exchange are checked to see if they are still the 200 biggest companies. This is when some leave the ASX200 and others join.

What can you invest in with ETFs?

With ETFs you can invest in a range of asset classes and individual assets. Asset classes are a category of investments grouped by characteristics and market behaviours, and can include cash, fixed interest, property, and of course shares. 

Examples of what you can invest in with ETFs include:

• Australian shares
• International shares 
• Industry sectors of share markets, like mining or healthcare
• Bonds
• Precious metals and commodities (like gold)
• Foreign currencies 

Investors often use a combination of asset classes and individual assets to diversify their portfolios, theoretically lowering their risk. 

When choosing an ETF, you might even factor in ethical considerations, like finding ETFs without fossil fuels for example.

ETFs can be bought and sold through a stockbroker, similar to the way shares are bought and sold. There are plenty of online stockbrokers around, so do your research when choosing your preferred broker. You might have to pay a brokerage fee when you buy or sell an ETF.

ETFs are differentiated by their names and ticker codes. A ticker code is usually between 3 to 4 characters long and is unique to an individual fund.

Buying ETFs

1. Compare trading platforms and brokers. Many brokers won’t have account minimums, transaction fees, or inactivity fees either.
2. Open a brokerage account. You can open a brokerage account online, even using your phone. You’ll need to provide personal details and ID, and be over the age of 18.
3. Transfer money into your trading account.
4. Compare the available ETFs. Narrow down your choices based on different factors, like administrative expenses, which funds they invest in (holdings), and past performance. Also, you’ll want to check what the Net Asset Value (NAV) is and compare it with the price of the ETF units. More on how to use these metrics when screening for your preferred ETFs below.
5. Check the ETF’s product disclosure statement (PDS) to find out the details. It contains information like what index, sector, or asset the ETF aims to replicate, the fees and costs, the investment risk, and how to complain if you’ve got a problem with the ETF.
6. Place a trade. Navigate to the trading tab of the broker’s website or application and search for your preferred ETFs by name or ticker code. You’ll find an option to place an order. Click that.
7. Check the unit price of the ETF to make sure you’re satisfied.
8. Place your trades.

How to choose the right ETF

When choosing the right ETF for you, you should consider the following factors:

• Administrative expenses. These may also be referred to as expense ratios, which cut into profit. The lower the fees, the better. 
• Brokerage fees. These are sort of like commissions. These fees can vary depending on the broker, it’s always worth checking how much you’ll be charged for buying and selling. These sorts of fees tend to eat into your profits. 
• Volume. Use this metric to find out how popular an ETF is by looking at the number of shares which traded hands over a given time period. Popularity may indicate how good a fund is, but it’s always good to do some reading before you jump into the most popular one. 
• Holdings. Check out the holdings of the ETF (which individual companies the fund invests in) to make sure you know where your money is going. 
• Performance. While past performance doesn’t indicate future returns, you can still use it as a comparison between the past effectiveness of different ETFs. 
• Trading prices. You should check out the current trading prices so that you know how many shares you can afford to buy. 

What is the Net Asset Value (NAV) of an ETF?

The Net Asset Value (NAV) is calculated by subtracting the liabilities (think management fees and other expenses) from the assets of a fund, then dividing it by the number of units in the fund. This helps you to compare how much it costs on the ASX with the value of the ETF. It reveals its intrinsic worth. 

You want to be able to buy or sell an ETF at a price close to the NAV per unit.

So now that we’ve learnt a little bit about ETFs, what are the pros and cons of investing your money into an exchange-traded fund?