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ETFs or index trackers are one of the most popular investment strategies and are seemingly growing in popularity. In this blog, we will cover everything you need to know about ETFs.
ETF is short for Exchange Traded Fund. Which if anything, just makes them sound more complicated than they really are. In reality, they’re quite straightforward.
ETFs track the performance of individual select stock markets. Some countries have several stock markets, others have just one.
For example, the USA has many stock markets including the S&P500 (tracks 500 of the largest companies listed on stock exchanges in the United States), the NASDAQ (which mainly tracks US Technology companies) and the Dow Jones (which tracks 30 prominent US companies)
These stock markets are made up of a collection of publicly traded companies. The performance of the stock market is depending on the price movements of the underlying companies.
ETFs are generally regarded as a low-cost investment strategy. ETF investing is known as a passive investment, as you simply track the market. Passive investing is the opposite of active investing where you have a fund manager selecting individual stocks attempting to “beat the market”.
Active funds are therefore generally more expensive, but look to yield higher returns, however, they do not always manage to achieve that goal.
ETFs can cost between 0.1% and 1.2% to invest into per annum. Active funds generally cost between 1%-2.5% per annum.
ETFs are often considered a good risk management tool as they provide investors with the ability to spread their funds across many different companies.
Certain stock markets hold only the largest 100 companies, for example, the FTSE 100. So when the lowest valued company drops in value it swaps out for another company. Other markets like the S&P 500 have a set list of companies.
The risk of ETFs are greatest when you have a broad market crash and the value of all or most of the companies drop.
There is also risk when you buy into a narrow ETF for example an ETF that tracks only one industry e.g. Ishares Clean Energy ETF. These types of ETFs are sensitive to anything which impacts the whole industry. In the example of the Clean Energy ETF, a drop in global oil prices is likely to have a negative impact on the ETF’s performance.
This is of course very dependent on the ETF. Each individual ETF will have its own performance.
The S&P 500 – The average annual return since its inception in 1926 through 2018 is approximately 10%–11%.
The FTSE 100 – The average annual return from 1984 through 2019 is approximately 7.75%.
This completely depends on what you are looking to achieve along with your personal financial situation.
Some commentators promote a “Core Satellite” model which involves between 60-80% of funds being invested into passive ETF investments with the other 20-40% being in active investments.
In order to find a portfolio that matches your financial objectives, we recommend meeting with a financial planner who can help you construct a globally diversified portfolio.