How ETFs work

Exchange Traded Funds (ETFs) are pooled investment securities that trade on exchanges like the ASX (Australian Securities Exchange) or the NYSE (New York Stock Exchange). Similar to trading ordinary shares, you can buy and sell ETF units on these exchanges. When you invest in an ETF, you are buying units that represent a share of a fund managed by professionals. This fund owns a ‘basket’ of shares or other assets. The price you pay reflects the net asset value of the fund’s portfolio, which is the fund’s assets minus its known fees, divided by the number of units.
You can access ETFs via your online share trading account or through your stockbroker. You will need to know the ticker code that relates to the ETF. As at June 2024 there are over 380 ETFs listed in Australia across the ASX and CBOE exchanges from which to choose.

Why are more people investing via ETFs?

ETFs offer immediate diversification, allowing you to own a slice of many investments in a single trade. Instead of putting all your money into one company, ETFs enable you to invest in a mix of shares, bonds, commodities, property, currencies, and even crypto assets. This diversification spreads your risk and is generally more cost-effective compared to buying individual securities. ETFs can also be cheaper than traditional managed funds. Additionally, ETFs provide transparency, as their holdings are disclosed daily, helping you ensure the investments align with your goals and values.

Passive versus actively managed ETFs

It is important to know the difference between a passive and actively managed ETF as you will need to decide which is the right option to match your investment goals.

Passive investing with ETFs involves selecting funds that track specific indexes or benchmarks rather than actively picking stocks or other securities.

Typically, passive ETFs charge lower fees which allows you to capture more of the capital gain if the ETF increases its net asset value, as well as removing much of the complexity in active asset management. The risk with this type of investment is it largely moves up and down with the market or sector that the ETF is tracking.

Active ETFs rely on the skills of the fund manager to actively pick and choose investments with the aim to outperform an index. You are likely to pay a higher fee and expect to capture higher returns when markets or sectors are in favour. Some active ETFs are also designed to offer greater protection when markets or sectors are down because their holdings are intentionally not constrained to structure of the index.

Sector specific or thematic ETFs

Thematic ETFs focus on niche sectors and global trends, not standard indexes like the S&P 500 or NASDAQ 100. These ETFs allow targeted investments in specific market segments. Recently, Australia has seen thematic ETFs that track trends like spot bitcoin prices, artificial intelligence, and climate-friendly projects. Both active and passive forms of thematic ETFs exist, each with its own risks. It’s essential to research and understand the assets an ETF holds and its investment strategy.

Whether you’re an individual investor or a seasoned financial professional, ETFs offer a straightforward and effective way to help achieve your investment goals.