Need to learn more about Exchange Traded Funds or ETFs? 

You've come to the right place.

This section takes you through the absolute basics of managed funds, index funds and ETFs, including how to buy them. 

What is an ETF?

An Exchange Traded Fund or ETF is simply a managed fund which is listed on the stock exchange.

Pulling Apart An ETF

A managed fund (called a ‘mutual fund’ in the USA) is a pooled amount of money that is managed by a professional funds management company.

Huh?

Just imagine you and 20 friends put $5,000 into a special bank account (your accountant calls it a “trust”). That’s the ‘fund’.

Now, if you get a professional to manage that fund, you have a 'managed fund'!

What is a managed fund?

An Exchange Traded Fund or ETF is simply a managed fund that can be bought and sold on the stock exchange.

For example, imagine one of your 10 friends — let’s call him, Dave — says to you that he, “wants out!”

In other words, Dave wants to exit the managed fund.

An ETF allows investors — even uncool people like 'Dave' — to log into their online stockbroking account, click ‘sell’, and withdraw their investment from the fund.

So far. So good.

Are All ETFs Also Index Funds?

No.

ETFs can use an “index” investment strategy (e.g. to track the ASX 200 index) or they can use “active” investment strategies, which is when a professional money manager picks the stocks he or she think will do best.

What is an index fund?

An ETF can also invest in different asset classes — not just shares.

For example, some ETFs invest in bondscash accounts or commodities (e.g. gold), and can often invest internationally (e.g. US stocks). It all depends on the strategy used by the ETF/fund.

You can read more about the ETF’s strategy in its Product Disclosure Statement (PDS).

How Does An ETF work & How Can I Buy Them?

Investors buy and sell into an ETF the same way they would buy a share on the market.

After the investor clicks “buy” in their stock brokerage account, the fund manager accepts the order and uses the investor’s money to buy more investments for the managed fund. The investor will receive ‘units’ in the fund (which appear in their brokerage account).

For example, Marley is a great investor in the making. If she bought into an ETF/fund which tracks Australian sharemarket, the ETF company responsible for the ETF would issue ‘units’ to Marley (which appear in her brokerage account). Behind the scenes, the ETF company uses her money (e.g. $500) to buy the Australian shares by pooling it with other investors’ money.

When Marley decides to sell her ETF ‘units’, the ETF/fund manager will sell the equivalent amount of shares and transfer the cash (the value of her units, less fees) back to her sharebroking account.

Are ETFs Risky? 

Like all investments ETFs have risks. Some of the risks will be listed in the ETF/fund’s Product Disclosure Statement (PDS), which can be found on the fund manager’s website.

Typically, ETFs will be susceptible to market rises and falls (known as “market risk”). There’s also the risk that something might go wrong behind the scenes (“execution risk”) and many other types of risk. The exact risks will depend on the strategy and the fund manager.

Knowing What’s Right

If you are confused about the potential benefits and risks of ETFs or investing, a trusted and licensed financial/investment adviser can help you make an informed decision. A qualified financial planner can take into account your risk profile, goals, needs and objectives.

You might also access the research of a professional investment research company to get ‘general financial advice’ (we offer this service). Regardless of what you do next, we think it’s good to read the PDS or ‘product disclosure statement’ before investing.

Now learn: Education on index funds