2. Why invest using ETFs?

ETFs are versatile and can cover, or support, a range of different strategies depending on their underlying investments. Funds that track equity markets can be quite broad, covering the breadth of the exchange, such as the Nikkei 225 index. Or, they can be more focused on sectors, such as a fund that tracks a group of mining companies.


In short

  • ETFs are versatile and cover a range of different investments
  • They can be broad, or cover specific sectors
  • They can also target different strategies, like dividends or growth
  • Diversification is one of their greatest strengths

They can even target certain investment strategies, such as companies that generate higher than average dividends, or have the potential to grow rapidly in value. At the heart of ETFs however, is their ability to use diversification to stabilise returns.

Case study: Diversification

Key takeaway: ETFs are a cost effective way to lower risk

Jack loves tech and his portfolio matches his passion.

He owns five shares, four of them are technology companies, and one of them is a bank. Lately, he’s noticed a problem. When one of the tech stocks goes down, most of the time, the others follow—sometimes by a lot. The bank share doesn’t seem to be affected.

Jack’s portfolio is too similar. Shares in similar industries will typically move in the same direction—he might benefit from increased diversification.

Jack could increase the variety of shares in his portfolio, buying a range of stocks from a number of different companies from more diverse industries which will reduce the effect on his portfolio should technology have a bad day. This will cost money in brokerage fees, and he might need a fair bit of capital to really see the benefit.

Or, he could invest in a broad-based ETF that tracks the entire sharemarket, adding instant diversification. The barrier to entry will be lower than buying a range of stocks, and he won’t have to constantly monitor each individual share.

Case study: Strategy

Key takeaway: You can select an ETF that’s fit for purpose

Jill’s a retiree on a limited budget and she wants an investment that will provide a steady income stream.

She’s just sold her family home as the kids have moved out and it’s time to downsize into something smaller and cheaper. And she made a tidy profit on the sale!

But what can she do with the extra cash? She’d much prefer to supplement her income, while letting her money grow, but her savings account is returning a paltry interest rate and she doesn’t know anything about the bond market.

Meanwhile, her son Bob has just started working and he wants to build a nest egg. He’s happy to take on a little more risk in the short term, as long as his investment grows over a long time period. He wants capital appreciation.

Jill could buy a high dividend paying share, like Acme Mining Co, that will give her a steady stream of income. But what if Acme’s share price collapses, or it reduces its dividend? She could also buy an ETF that invests in high dividend paying companies which will also provide a steady stream of income when it pays out distributions, while the ETF managers will spread the risk by investing in a diverse range of dividend paying companies.

Bob, however, wants a strategy that will grow in value over time. He could invest in an ETF that targets high growth companies, like those in the technology sector. Again, the ETF managers will spread the risk, investing in a number of growth stocks, and readjust the portfolio to target a certain level of capital appreciation.


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