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What is an ETF and How Does it Work?

By January 13, 2022No Comments

Attracting trillions of dollars globally, ETFs (Exchange Traded Funds) are hot. So, what is an ETF and how does it work? 

What is an ETF? 

An ETF or Exchange Traded Fund is a type of security that trades on an exchange like stocks.  

Typically, an ETF contains a basket of investments which it tracks. These investments could be stocks, commodities, currencies, assets or bonds. Some may be country-specific while others may be international. In fact, an ETF can be structured to track anything such as: 

  • An index like the ASX200 
  • An industry such as healthcare
  • A commodity such as platinum
  • By investment strategy 

Exchange Traded Funds explained 

An ETF tracks the value of its underlying index or assets. The fund provider owns the underlying assets and sells the shares to investors. Therefore, shareholders own a portion of the ETF but not the underlying assets. However, they may receive reinvestments or lump sum dividend payments for the underlying assets that make up the investment. 

ETFs trade throughout the day on an exchange at market-determined prices that are usually different from the underlying assets. The long-term returns will differ as well. 

As the ETF usually covers multiple assets, it can be a popular diversification option. 

How to buy ETFs in Australia 

You can invest in an ETF through online brokers, robo-advisors and traditional broker-dealers. Some brokers may have a large percentage of their investment portfolios as ETFs.  

How do ETF fees work? 

ETFs usually have lower fees than other fund types because they have lower expense ratios and fewer broker commissions. They also provide lower costs because the investor gets access to all the assets in the fund with one transaction. That means there’s only one transaction to sell. Some brokers may even offer zero-commission trading on their low-cost ETFs.  

While the costs may be lower, they will vary from fund to fund depending on who the issuer is, the complexity and the demand for that ETF. Even ETFs that track the same assets or index may have differing costs. 

What is an ETF vs mutual fund and stock 

An ETF is traded like a stock on an exchange, whereas mutual funds only trade once a day after the market closes. As a result, ETFs tend to be more liquid and cost-efficient than mutual funds. 

ETFs differ from stocks because they can represent and track thousands of assets – unlike stocks which represent just one company or asset. Therefore, ETFs are more diversified. 

ETFs offer the ease of stock trading and the diversification benefits of mutual funds with the added benefit of lower fees. 

Choosing the right investment options for you 

On paper, ETFs look like an opportunity not to be missed but you need to choose wisely. Balance the pros of transparency, lower fees and diversification, against the cons which include potential broker fees, liquidity issues and the risk that an ETF will close, causing a possible loss for the investor. 

At Treysta, we’re here to help you create wealth through an investment portfolio that considers your risk appetite, lifestyle, values, and current situation. We’ll also help you identify potential investment opportunities that will work well for you now and in the future. We’re here to guide, educate and help you make sound investment planning decisions. 

To receive monthly tips and educational insights, follow us on Facebook or Instagram. If you would like to learn more about our approach to investment planning, call us on 02 9241 2575. 

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