What is an Exchange Traded Fund (ETF)?

CommSec CommSec

19 December 2018

An Exchange Traded Fund is often referred to as an ETF. They’re built like managed funds, but they can be bought and sold on the share market like ordinary shares.

You can think of an ETF as a basket of investments. Each ETF purchases a range of assets (like shares, bonds, commodities and currencies), and their aim is to match the performance of a particular market index or benchmark.

For example, an ETF might aim to track the ASX200 Australian share index by investing in the top 200 Australian companies trading on the ASX.

Another ETF might aim to track a particular commodity (like gold or silver), or an industry sector (like healthcare or mining). Some ETFs can even give you exposure to international markets.

Benefits of investing in an ETF

Diversification
There are over 160 ETFs to choose from on the ASX, and owning units in an ETF can give you exposure to a group of assets, markets, or sectors. Because each ETF represents a basket of assets, the value of your investment is spread over multiple underlying companies (rather than being concentrated in just one company). This means you could achieve diversification even in a small portfolio.

Ease of trading
ETFs can be bought or sold just like normal shares on the Australian share market. You can log in to your trading account and make a purchase or sale – the same way you would place an order for shares.

Generally lower costs
ETFs are often classified as passive investments (rather than active ones) because the ETF manager doesn’t ordinarily have to do a lot of frequent buying and selling. The ETF will charge a management fee, but it’s usually lower than the kind of fee charged by a managed fund. Managed funds are trying to beat the market rather than match it – so they charge a higher fee to cover their management costs.

International exposure
ETFs make it easy for you to access different types of assets and investments around the world. Some investments are not always easy to do yourself – like buying commodities or investing in overseas markets like the New York Stock Exchange.

Risks of investing in an ETF

Prices can rise and fall
Like any other investment, the value of ETFs can rise and fall. They generally aim to match the performance of the market that they are tracking. So if the market rises, the ETF will generally rise to match. If the market falls, the ETF will generally fall as well.

Currency risk
If you buy units in an ETF that tracks the performance of international shares or assets, you could be exposed to currency risk (the upward or downward movement in currencies). This can have a positive or negative impact on your investment.

Leverage risk
Some ETFs are leveraged, which means the fund uses debt or derivatives to magnify the returns of the index that it’s tracking. Unfortunately this means that losses can also be magnified, which could affect the performance of your investment.

Tax implications
There could be tax considerations, depending on your circumstances. For example, if you invest in an ETF that’s located in another country, foreign taxes may apply. Speak to your professional tax adviser for more information.

How to buy and sell ETFs with CommSec

If you’re looking for a tool to help you choose an ETF, you can try the CommSec ETF Screener. Once logged in, click on “Quotes & Research”, followed by “Tools” and then “ETF Screener”. From here, you can browse ETFs by asset class, region, market cap, and sector.

Before you invest in a particular ETF, you should research the fund, read the PDS and make sure you understand the potential risks. If you have any questions, contact your financial adviser.

In terms of buying and selling ETFs, the process is much the same as buying or selling shares. Simply log in to your online trading account and place an order.

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