5 reasons to invest in ETFs

Posted: 29 November 2019 9:46 am
News

Left: Hands holding a smartphone with a stocks and shares data on it. Right: ETF expert Adam O'Connor.

ETF expert Adam O'Connor shares some of the biggest benefits they can offer.

More and more investors are turning to ETFs. But if you're not very familiar with them, you might be wondering why.

ETFs offer benefits to both seasoned investors and those just starting to build an investment portfolio, including portfolio diversification, cost-effectiveness and accessibility. Below are five key benefits of ETFs and how they compare to investing in direct shares or managed funds.

1. Cost

ETFs provide investors with a cost-effective way to gain exposure to a market, an asset class (such as stocks, bonds, commodities or real estate), as well as different sectors (healthcare, banking, energy, etc) and thematics (retirement income, sustainability, etc).

The first ETFs were what we could call plain or vanilla index-tracking funds. What that means is that they have an underlying index that is used to track the performance of different investments. For example, you could invest in an index that tracks the top 200 ASX-listed companies.

In this scenario, the index would generally be a market capitalisation-weighted index and the ETF would aim to track the performance of it – less any fees and costs – by holding the underlying stocks in the same proportion they are held in for the index.

This is known as "passive management", as opposed to "active management" where the fund manager tries to pick shares (or other investments) in an attempt to outperform an index. While an active manager is paid to make decisions around which companies to hold in the portfolio, the structure of ETFs means they typically charge much lower fees.

Lowering the overall cost of a portfolio is one way you can improve your investment outcomes over the long run because, while the ups and downs of the market can't be controlled, what you pay in fees can.

2. Exposure

ETFs give you an opportunity to invest in specific industries or trends by offering themed investment portfolios that could include both local and global companies.

Consider this scenario: you're reading an article about the rise in cybercrime and the increasing cost of cybersecurity for governments and businesses. You think this is an area you'd like to invest in but you don't know any cybersecurity shares or where to begin.

A themed ETF – like the the BetaShares Global Cybersecurity ETF – could give you access to a diversified portfolio of global cybersecurity companies without you needing to select and invest directly in individual companies.

As well as thematic investment options, ETFs also give Australian investors the ability to easily gain exposure to global markets and to asset classes that were previously difficult for most investors to access, such as fixed income, gold and currency.

3. Diversification

Savvy investors are always looking for opportunities to diversify their portfolios in order to help reduce (or spread) the risk of fluctuations in their investments. Some people even describe diversification as the only "free lunch" in investing.

The ease of access to various exposures that ETFs provide can allow investors to diversify away from a single asset class – like Australian shares – and into other asset classes, like global shares or bonds. When these exposures are blended together in a portfolio, it can offer significant diversification benefits.

Another important factor: because many ETFs aim to track an index (which comprises a basket of underlying stocks or bonds) an investor can obtain diversified exposure to those particular assets in one ASX trade. This means that ETFs can mitigate risk by limiting the impact of price movements in individual securities on the outcome of the whole portfolio. In the past, people investing in direct shares would have had to make many individual trades to achieve the same results.

4. Liquidity

In its broadest sense, "liquidity" simply refers to the ease with which an investor can buy or sell an investment without affecting its price.

With the traditional unlisted managed fund, the process of buying and selling units in the fund typically involved submitting a form to the fund manager directly. The price you received was based on the net asset value of the fund at the end of the day.

But ETFs allow you to buy and sell units at any time through the trading day, at a known price – exactly as you would a share. As well as providing convenience and peace of mind, this means increased transparency and price certainty, which are crucial for many investors.

5. Convenience

Ultimately, the core advantage of an ETF for most investors comes back to convenience. Convenient access to different markets, asset classes and thematics. A convenient way to build a diversified portfolio of particular assets – and across different asset classes. A convenient way to buy and sell units in a fund.

We often refer to ETFs as simply an evolution in technology. And we use the analogy of an LP record becoming a CD, and ultimately being largely replaced by digital music platforms like Spotify. The digitalisation of music has meant we no longer need to carry around physical CDs. The digitalisation of the stock exchange has meant we no longer need to write directly to the fund manager to enter or exit a position – you can just trade it online at the push of a button. Why do we ultimately choose to transition from one technology to another? Convenience.

But remember: before you invest in ETFs, it's also important to consider the associated risks, including market risk, index tracking risk, security specific risk and foreign exchange risk (as applicable). To find information on the risks and other features of each ETF, make sure you look at the relevant product disclosure statement.

Adam O'Connor is a member of the BetaShares Distribution team responsible for supporting institutional and intermediary broker and adviser channels. Prior to joining BetaShares, Adam worked in stockbroking and advisory with Bell Potter Securities. Adam holds a Bachelor of Laws with Honours and a Bachelor of Business (Finance) from Queensland University of Technology. Adam also holds a Diploma of Stockbroking from Deakin University and is an accredited Financial Adviser in Securities and Managed Investments and Superannuation.

Disclaimer: The views and opinions expressed in this article (which may be subject to change without notice) are solely those of the author and do not necessarily reflect those of Finder and its employees. The information contained in this article is not intended to be and does not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort. Neither the author nor Finder have taken into account your personal circumstances. You should seek professional advice and read the offer document for any investment product before making any further decisions based on this information.

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