Wouldn’t it be great if you could easily invest your money into some asset that provided interest that far exceeded that of a bank? Wouldn’t it be good if it was low risk and you didn’t have to pay someone a bucket-load to manage it for you?
Traditionally large scale investors have entrusted their fortunes to the likes of money grubbing hedge fund managers. The result is, on average, comparable growth to an index such as the ASX200. What a fund manager will do is take your money and a pool of other people’s money and invest in a variety of different stocks that they believe will outperform the market. The outcome is, most likely, a diversified portfolio of stocks ranging in risk according to the risk profile you have decided. The downside is that these hedge fund managers are shaving a couple of percent off your bottom line earnings. Where you might achieve a combined dividend and capital growth of 8 %, this might be reduced to 6 % after getting struck by management fees.
The reason I describe this is because there is a simple alternative, cue ETFs. An ETF or exchange traded fund is an investment fund that is traded on the stock exchange, similar to traditional stocks. An ETF is effectively a bundle of different stocks. When you buy one stock in an ETF you inherently achieve diversification in many stocks. The weighting of each stock in an ETF varies i.e. it may be made up of 20 % Wesfarmers, 20 % NAB, 20 % ANZ, 20 % Telstra and 20 % Woodside. This is an oversimplification but shows the basic principle behind an ETF.
There are ETFs for a range of purposes: high risk, low risk, high dividend yield, high capital growth etc. You can also gain exposure to overseas markets through an ETF that trades on the ASX.
So what are the pros and cons of ETFs?
Pros:
– Low risk through diversification. Risk profile can vary depend on the ETF.
– Can achieve diversification without being held back by significant brokerage costs.
– Low management fees compared to a hedge fund. Where a hedge fund is actively managed at rates of roughly 2 %, an ETF is passively managed and rates are as low as 0.04 %.
Cons:
– The main con behinds ETFs is their liquidity. They may be tradeable like a normal stock on the ASX but the rate at which people buy and sell ETFs is generally less than traditional stocks. This can create a gap in the intraday pricing of the stock, meaning that you may have to wait longer than a normal stock to sell, if you want to realise the true value of the ETF.
For purchasing ETFs on the ASX there are two main companies that offer various ETFs. These are Blackrock and Vanguard investments. Purchasing the ETF is as simple as finding the three later ASX code for the ETF on the Blackrock or Vanguard websites and purchasing them on your broker app like any other stock!
John C. Bogle, founder of Vanguard, discusses the numerous reasons why one should invest in ETFs in ‘The Little Book of Common Sense Investing’. If you aren’t sold yet, I definitely recommend the read despite its dryness.
Jordan Bentley – BEng(Chem)(Hons)/BMath
The Informed Investor 