Investing in ETFs in Australia – Forbes Advisor Australia

Investing in an ETF involves receiving a bundle of assets that can be bought and sold during market hours. In theory, this lowers the risk and exposure to losses while simultaneously diversifying a portfolio. That also lowers risk levels, because different asset classes perform well at different times.

A fund manager tracks the value of either an index like the ASX200 or a specific commodity like gold. The value of the ETF increases or decreases with the index or asset that is being tracked.

There are two types of ETFs—synthetic and physically backed.

Synthetic ETF

A conventional ETF invests in stocks with the stated goal of replicating the performance of a specific index, while a synthetic ETF is a pooled investment that invests money in derivatives and swaps.

Synthetic ETFs can often offer higher potential returns, but they also often come with higher risks.

A synthetic ETF does not directly invest in assets, but it is ideal for hard-to-access assets. An example of this is the commodity of crude oil: instead of owning barrels of it, a synthetic ETF that tracks it will hold a series of oil futures contracts. These agreements are set up with a third party who promises to pay an agreed level of return when oil reaches a certain price.

Physically backed ETF

Physically backed ETFs invests in all the securities in the index, or a sample of them. The majority of ETFs are physical. For example, an ETF that tracks the S&P 500 Index will consist of either all those 500 companies in the index, or only a representative sample of the basket of stocks.

When you invest in an ETF that holds a type of stock, you are investing in equities and becoming a fractional owner of the companies within that fund. Technically speaking, ETFs are not equities on their own – but many ETFs are made up of equities.

ETFs pay dividends just like any other dividend-paying stocks, and the dividends are typically in the form of cash payouts or issuing further shares.

International ETFs

An international ETF invests in foreign-based securities that are global, regional, or focused on a particular country. Investors can use them to diversify the geographic and political risks associated with their portfolios.

Commodity ETFs

Commodity ETFs provide exposure to the price changes of raw materials, such as metals or natural resources. They often structured as a physical commodity or as futures-based funds that trade on exchanges and don’t require storage like a physical commodity does.

Bond ETFs

Bond ETFs exclusively invest in bonds and are similar to bond mutual funds because they hold a portfolio of bonds with different particular strategies and holding periods. Bond ETFs are passively managed.

Crypto ETFs

A cryptocurrency ETF tracks the price of one or multiple digital tokens and consists of numerous cryptocurrencies. Cryptocurrency ETFs are typically the extended use case of blockchain technology. For example, Bitcoin ETFs are the first crypto ETF that tracks the price of the most valued cryptocurrency among digital assets, BTC.

Currency ETFs

Currency ETFs track the relative value of a currency or a basket of currencies. It enables everyday investors to gain exposure to the forex market through a managed fund but without the complication of placing individual trades.

Start by considering the ETF’s underlying index to determine the exposure you will receive. Evaluate tracking differences to see how well the ETF delivers its intended exposure. Higher volumes and tighter spreads are an indication of liquidity and ease of access.

You can buy and sell units in an ETF through a stockbroker—it’s just like buying and selling shares. When the title or legal ownership of an ETF is exchanged for money, the broker handles the settlement. These brokers offer a personalised service, sometimes even recommendations, so usually attract higher fees.

You can also access an ETF  through a range of online brokerage sites that allow you to open your own account. You won’t receive any personalised recommendations, however, the fees will be lower.

ETFs are especially popular with young investors because they are lower cost and therefore more accessible: they provide exposure to a range of investments that would likely be out of reach for many people. ETFS are cost-effective because they only require one transaction to trade a single diversified investment.

ETFs have several advantages over traditional, open-end funds. The main ones are trading flexibility, portfolio diversification and risk management and tax benefits. They are also transparent: ETFs publish details of their underlying assets frequently, and sometimes even daily.

Every investment comes with certain risks, and ETFs are no different. ETFs can help an investor to diversify, but there is still the risk that the market or sector being tracked by the ETF could fall in value. This will result in the value of the ETF investment being reduced.

There is also a currency risk. That is, if the ETF invests in international assets, you face the risk of currency movements impacting your returns. Some ETFs are ‘currency hedged’ which removes this risk.

Another downside is that an ETF’s price can move away from the value of the index or asset it is trying to track. It could be due to illiquidity of the underlying assets, fees or taxes. It means that the ETF is bought or sold when it is not trading at the net asset value.

And although ETFs generally have lower costs than mutual funds, investors still need to pay a real or virtual broker to facilitate the trade. These range from around $8 to $30, and they’re paid every time shares in a fund are bought and sold. It lowers investment performance, especially if small amounts of shares are purchased continuously.