What is an ETF and why should they be part of your retirement plan?

When you’re getting started on your ETF journey, there can be a lot of information to process, which can sometimes be overwhelming. Let’s get you started.

An exchange-traded fund (ETF) is like a cross between an index managed fund and a share. ETFs are one of the world’s fastest growing categories of investment products.

They’re like a managed fund, but with some differences. An ETF is an open-ended investment fund with access to almost every corner of the market and every major asset class and traded on the Australian Securities Exchange (ASX).

In investing terms, ETFs allow you to buy a suite of shares or assets in a single ASX trade and allow you to invest in markets or assets that otherwise can be difficult or expensive to access.

And because you are buying diversified exposure, if one of the shares held by the ETF performs badly, it is unlikely to have a significant effect on your overall investment.

ETFs offer the same diversification benefits as actively managed funds, but usually at a lower cost

Most ETFs are passively managed funds that aim to track the performance of a given index or asset class and provide the returns of that index or asset class – less any fees. Because there are no analysts or fund managers being paid to try and beat the index, management costs are typically lower than for actively managed funds.

Traditional managed funds, on the other hand, are usually actively managed by a fund manager trying to beat the market with their investing expertise, which often means higher costs for you.

Some actively managed funds may outperform ETFs in the short term, but history has shown they rarely outperform them in the long run.

In a nutshell, ETFs are simple, transparent, cost effective and flexible investment vehicles that can provide diversified exposure to a range of asset classes.

Read more: The funds that cleaned up and those that failed

Who will help you?
Investing in ETFs is simple. As they trade on the ASX, you can buy ETFs as you would shares via an online broker, your stockbroker, or your financial adviser.

When you’re ready to buy or sell an ETF, simply use the specific fund’s ASX code. A list of the relevant ASX codes for each product can be found on the specific product pages.

If you already have a portfolio and are willing to put in the time managing it, then you can use ETFs to assist in balancing risk and potential return and achieve your investment goals.

You may need some advice from a finance professional before making these types of investment decisions. Try to find a fee-only financial planner – or someone who does not earn commissions on your investments.

“Often, they have heard of advisers and brokers, online platforms, and apps that can invest their spare change, but are confused about where to start,” says BetaShares associate account manager Tom Wickenden.

“It’s no surprise – investing has changed a lot in recent years, and fast.”

There are three main ways to invest: person to person, through online brokers, and through application brokers.

“Both the app-broking and online broking spaces are continuing to evolve with new platforms frequently emerging, aiming to provide simple, low-cost access to the benefit of all types of investors. There are plenty of options to suit different types of investors, each with its pros and cons,” says Mr Wickenden.

“With your savings account likely earning less interest than your weekly coffee bill and all these options now available – there really has never been a better time to start investing.”

Read more: Retirees jumping on the ETF bandwagon

Choosing the best ETFs
There are more than 200 ETFs available on the ASX. In choosing the funds that are right for you, it’s important to consider your financial circumstances and objectives.

Are you looking to round out an existing portfolio of stocks or managed funds? Then your ETFs should complement your existing investments.

If you are just starting out, you should generally include stocks and bonds and diversify within those two broad asset classes.

ETFs can provide exposure across stocks, bonds, hybrids, currencies and commodities, so can be great building blocks when constructing a portfolio from scratch.

Mix and match your holdings appropriately
Create a well-diversified portfolio that seeks to include various asset classes that are uncorrelated. This means that in periods when one part of your portfolio does not perform well, another part of the portfolio may perform better, mitigating the overall effect. Try not to invest in different ETFs that all focus on the same stocks.

As a start, you could consider investing in an Australian equities ETF, an international equities ETF, and a fixed income ETF.

Pay attention to cost
Don’t pay more than you need to. Index-tracking ETFs are typically low cost, some more so than others. If two ETFs offer similar exposure, compare their management fees when making your decision.

Your goal should always be to have a well-diversified collection of investments

The management expense ratio (MER) is an annual cost (accrued daily in the fund) that covers management and administrative fees, and operating costs.

An MER of 0.45 per cent p.a. means that your investment will cost you $4.50 for every $1000 you have invested annually.

Don’t put all your eggs in one basket
ETFs offer a convenient and easy to manage way of building diversification into your portfolio. The exposure across multiple investments that an ETF provides is one form of diversification. But it’s also important to ensure there is diversification between the ETFs in your portfolio – there’s little point choosing two ETFs that track similar indices. Choosing ETFs that track dissimilar indices will result in a more diversified portfolio.

Spread the load
Make sure that no single ETF makes up too large a proportion of your portfolio.

What else should you look for in an ETF?
As well as the type of exposure an ETF provides, and the costs of the fund when looking for ETFs, it’s important to consider who the ETF issuer is.

You’re going to want a reliable and experienced provider with a proven track record. Choosing an investment that meets your needs along with a client-focused provider, such as BetaShares, that is committed to education and product innovation, may be the perfect match.

Read more: ETFs: What are they, why consider them and how to start investing now

When you have a broker in place, ask them these questions:

  • How much risk should I be taking with my money?
  • How much of my portfolio should I put into ETFs?
  • Given the size of my portfolio, how many individual ETFs would you suggest?
  • Which asset classes should I use ETFs to invest in?
  • What management fees do the ETFs you are recommending charge?
  • Which selection of ETFs would you advise for an optimally diversified portfolio?
  • Do I keep my present investments, or sell them? If I keep them, which ETFs will complement those investments?
  • How can my superannuation/income stream/pension complement my new ETF portfolio?

What do you need to know before you invest in ETFs?
There are nine things to understand including an ETF’s structure, whether the ETF is currency hedged, ideal time to buy and sell on the ASX and more.

1. Understand an ETF’s basic structure and liquidity before you start to trade.

2. Know what the Net Asset Value (NAV) is, and then use the Indicative Net Asset Value (iNAV) (if one is available) to help determine the price to trade.

3. Is the ETF Currency Hedged or Unhedged?

4. Understand bid and offer spreads.

5. Know the difference between ‘market orders’ and ‘limit orders’.

6. Time when you buy/sell an ETF.

7. Can ETFs help deal with market volatility?

8. What happens to my assets in the event of a product issuer’s bankruptcy?

Learn more about what you need to know before you invest in ETFs.

Do you know much about ETFs? If so, how has your experience been? Would you like to know more? Why not send us your questions to [email protected] or share your thoughts in the comments section below?

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BetaShares Capital Limited (ABN 78 139 566 868 AFSL 341181) (BetaShares) is the issuer of the BetaShares ETFs. Before making an investment decision, investors should consider the Product Disclosure Statement (PDS), available at www.betashares.com.au. This information does not take into account any person’s objective’s, financial situation or needs and is not a recommendation or offer to make any investment or to adopt any particular investment strategy. Investors should consider the appropriateness of the information taking into account such factors and seek financial advice. Investments are subject to investment risk, investment value may go down as well as up, and investors may not get back the full amount originally invested. ASIC’s MoneySmart website has useful information for people considering investing. The MoneySmart resources can be found at https://www.moneysmart.gov.au/ investing. ASIC’s MoneySmart website has no affiliation with BetaShares.

Written by Leon Della Bosca

Leon Della Bosca has worked in publishing and media in one form or another for around 25 years. He's a voracious reader, word spinner and art, writing, design, painting, drawing, travel and photography enthusiast. You'll often find him roaming through galleries or exploring the streets of his beloved Melbourne and surrounding suburbs, sketchpad or notebook in hand, smiling.
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