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Exchange traded funds (ETFs) are investment funds made up of multiple shares or other assets that can be bought and sold on a stock exchange. This means that you invest in them through a share trading platform, the same way you would buy stocks.
ETFs have become popular in the last few years in Australia thanks to the rise of index fund investing and because you can invest in multiple shares in one trade. Our guide covers everything you need to know about ETFs, including how they work and how you buy in.
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ETFs are bought and sold just like regular stocks, so you'll need to choose an online broker before you are able to invest.
Important: Share trading can be financially risky and the value of your investment can go down as well as up. Standard brokerage is the cost to purchase $1,000 or less of equities without any qualifications or special eligibility. Where both CHESS sponsored and custodian shares are offered, we display the cheapest option.
An ETF is a low-cost investment fund that can be traded on a stock exchange such as the Australian Securities Exchange (ASX). These funds are created by ETF issuers and fund managers and are made up of a basket of securities such as shares, cash and bonds.
Each ETF is allocated an ASX code and can be bought and sold by investors the same way that you would buy and sell shares. By investing in ETFs, you can easily create a diversified portfolio and spread your investment across a wide range of asset classes, including Australian shares, global shares, fixed income, debt, foreign currencies, commodities and metals.
You don't actually buy individual ETFs, instead you buy ETF units - similar to company shares. You buy these ETF units the same way that you do shares, through a broker or online share trading platform.
After you've signed up to a brokerage and decided which ETF to buy, you can search for the name or ticker code of the ETF. You'll soon notice that each ETF has a price. This is called the unit price.
Say you want to invest $1,000 into your ETF of choice and the ETF unit price is $1. The brokerage service you use also charges $20 each time you place a trade (leaving you with $980 to invest). Excluding the brokerage fee, you would buy 980 ETF units at $1 each.
Before you buy, it's a good idea to compare the ETF unit price with its iNAV price (available from the ETF issuer). The iNAV price tells you how much the price of the ETF should be relative to the assets it holds. When there's a lot of volatility in the market, sometimes these two prices can be very different. If the ETF unit price is higher than the iNAV price, then you're probably paying more than what the ETF's true value is.
For this reason it's a good idea to set a 'limit order' based on the iNAV price when you're buying ETF units. A limit order allows you to select the price that you'd like to buy the ETF at. Once the ETF falls to that price, your order will go through.
Having trouble choosing an ETF? Read our guide to Australia's best performing ETFs.
While standard ETFs typically track a stock market index (called "passive" investing), others hold various other types of securities (such as cash) or are actively managed. Active management is where fund managers frequently buy and sell stocks and other assets to better improve the fund's performance.
There are many types of ETFs these days, it all comes down to the strategy chosen by its fund managers.
ETFs have a reputation for being low-risk and for delivering decent returns over a long period of time. That’s mostly true for index fund ETFs, but listed funds today come in many shapes and sizes, and some of them carry as much risk as any stock on the ASX.
To make matters more confusing, the terms are frequently muddled between fund managers and investors. As a way to avoid confusion, ASIC and the ASX has broadly labelled them all "exchange traded products" (ETPs) and subcategorised them into "ETFs" (index funds), exchange traded managed funds (ETMFs) and synthetic funds or structured funds (SPs).
Despite their efforts, you'll find they're mostly just referred to as "ETFs" by investors and analysts.
On the outside, these can appear to be very similar. However, they're quite different in terms of strategy and level of risk.
ETFs access investment assets in two ways: physically or synthetically. ETF issuers of a physical (or standard) ETF have purchased the underlying assets on the index it aims to replicate.
On the other hand, structured or synthetic ETFs try to replicate the performance of its underlying assets through the use of derivatives. This is because it’s not always practical to hold physical assets. For example, gold or commodity ETFs are often synthetic. Instead of investing in an actual lump of gold, you’re investing in a contract that promises returns based on the commodity’s price movements.
Warning: Because structured products may use complex investment strategies, they can be much riskier than a standard index ETF.
You can read more about synthetic ETFs here.
Active ETFs or ETMFs are actively managed listed funds. Fund managers aim to outperform the market by manoeuvring securities within the fund. As such, they may carry higher risk than passive index funds and usually charge higher fees for the service.
Commodity ETFs, or exchange traded commodities (ETCs), track the performance of an underlying physical commodity, such as gold, natural resources and agricultural products.
When you invest in an ETF, the first cost you'll be aware of is the ETF unit price. However, there are other less obvious costs you need to be aware of. While ETFs typically charge lower fees than unlisted managed funds, this isn't always the case.
You should always read the PDS provided by the ETF issuer for full details of any fees that apply and how they will affect your investments. Here are the main costs to take note of:
Some ETFs pay dividends if the underlying company stocks pay dividends. However it also depends on whether the fund manager chooses to pass this on, so check this first if this is a priority.
Most of the time ETFs will pay their dividends on a quarterly basis, though this isn't a rule. If you're interested in ETF dividends, check the yield, how often it's paid, and whether you can reinvest the payments back into the ETF if you choose or if it's paid into your account.
Like share prices, the price of ETF units can fluctuate day-to-day. However, many ETFs move up and down in line with the index they are tracking, so there are a few simple tips to keep in mind to help you get more out of your ETF investments:
There are many reasons to consider investing in ETFs:
ETFs are often advertised as being a safer investment than directly buying shares on the stock market, but this is not always the case. Although many ETFs are relatively safe index funds that track major indices, it's also possible for an index fund to track a volatile global market, such as rare earth metals or the oil market.
You should also remember that technically any kind of asset can be bundled into a fund as well as risky derivative-type products. This means that not all ETFs are passive index funds as you may believe. Always do your research before you invest. Here are some of the main risks to consider:
Synthetic ETFs have all the same risks as physical ETFs, but they also expose you to a few additional potential problems:
Before deciding whether ETFs are the best investment solution for you, make sure you’re fully aware of how they work and have an in-depth understanding of all the risks involved. Read the PDS closely, ask questions of the ETF issuer if you’re unsure about anything and consider seeking help from a qualified financial adviser.
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