HOW ETFs WORK
ETFs have become a phenomenal global success and continue to increase in popularity as one of the fastest-growing investment products of recent times. They are essentially investment funds traded on the stockmarket. They are designed usually to track the performance of an index or mirror the price of an asset, such as the S&P/ASX 200 or the price of gold.
“Investors are drawn to ETFs for their transparency and ability to offer diversification through a basket of securities in one single trade,” says Meaghan Victor, from State Street Global Advisors. “Their low cost and simple characteristics have also meant they have democratised investing, giving investors access and choice to equities that decades ago would have only been accessible to a select few.”
About 20 years ago, Australia had around five ETFs with a few hundred million in funds under management. Today, Aussie investors have splashed out over $100 billion across 265 ETFs listed on the ASX.
Getting started
ETFs trade just like shares. Charlie Viola, from Pitcher Partners, suggests a good starting point is to pick a small group of ETFs and then invest in them over time.
“There is no real need to try and finesse the investing too much, and sometimes just taking pure broad-based index exposure where you can invest slightly more material amounts on a regular basis makes good sense. The trick is to start investing and keep building,” he says.
If you had a few hundred or a few thousand dollars, Viola says brokerage becomes a key factor. Investors shouldn’t put themselves in a situation where the cost of trading takes a big bite out of investment returns, so research your broker and its fees carefully.
Do they pay dividends?
The short answer is yes, but it depends on the ETF and its underlying investments. If the stocks in an ETF pay dividends, then it is required to pass those dividends and any franking credits to investors. The table indicates the dividend yields paid out by the ETFs selected by our experts.
What to know before buying
Before making an initial investment, our three experts agree that it’s critical to do your homework.
Starting with the basics, Victor suggests: “Look at the issuer of the ETF – what is their track record? Which index are they tracking? Understand the total cost of owning the ETF, not just the expense ratio. And read up on the underlying holdings – at the end of the day, ETFs are usually transparent meaning you can ‘look under the hood’.”
Whelan agrees, adding that investors should seek to ensure they get the right exposure, and at the best possible price, by taking into account the following further considerations:
• Know the best time to buy. Don’t trade ETFs too early during the trading session as spreads can be wide. He suggests buying after 10.30am AEST and using limit orders.
• Know your hedging. Some overseas ETFs have currency hedging, and some don’t. It’s important to consider whether you want to neutralise the risk of currency movements using a hedged ETF or if you’re comfortable with unhedged exposure.
• Know if you’re using a leveraged product. Some ETFs contain leverage, and for beginners it’s best to avoid them. “You’ll find that as the market swings against you, your losses could be two or three times as bad. So be careful, and know that they cost more too,” says Whelan.
“If you decide to keep it simple and do your homework, then ETFs are an amazing innovation. They offer investors the convenience of focusing on a theme rather than getting distracted with stock and manager selection – and they keep your trading costs down.”