Thanks to the ease of use and relative affordability of Exchange Traded Funds (ETFs), their popularity has exploded in recent times. Over the past year, the Australian ETF market grew by a staggering 74.9% (compared to the slightly further-ahead US market, which grew 23.7%).
Even if you’re not exactly sure of how ETFs work, you’ve almost certainly heard of examples of them.
Vanguard, the largest player in the Australian market, provides several ETF options including the Australian Shares Index ETF, which tracks the S&P/ASX 300 (ASX:VAS) – the top 300 companies in Australia.
ETFs can also track specific industry sectors like tech, biotech, healthcare or even gaming. BetaShares offers a range of these, known as thematic ETFs. [link to article]
How do ETFs work?
ETFs are an easy way to invest in sectors you’re interested in, without hedging all of your bets on one company or startup.
You buy and sell into an ETF the same way you’d buy a share on the stock market. The difference is that you’re buying a ‘basket’ of stocks across one asset class, rather than a singular stock. These asset classes could be property, commodities (oil, gold, coffee, etc), crypto stocks, bonds, or sectors like tech, healthcare, or cannabis.
Broadly speaking, there are two different styles of ETF investing.
What are the differences between ETFs and mutual funds?
ETFs are often compared to mutual funds, and they do function in a similar way. But there are a few key differences between the two to understand.
- You can invest in ETFs throughout the trading day, whereas mutual funds are priced at the end of the trading day.
- ETFs generally have lower fees than mutual funds.
- ETFs may be more tax efficient. Mutual funds on the whole involve more buying and selling, which can lead to owing more capital gains tax. With ETFs, you’d only be taxed upon selling your investment.
- Mutual fund minimum initial investments aren't based on the fund's share price, but on a flat dollar amount.
ETFs and diversification
ETFs are inherently diverse. Your investment is spread across several stocks within one or multiple asset classes. This means passive investing in an ETF is generally likely to be lower-risk than the ‘all eggs in one basket’ approach of buying single stocks and shares.
These days, you can even buy an ‘EFT of ETFs’ for increased diversification. Vanguard offers a range of 4 broad ETFs built for different risk profiles (conservative, balanced, growth and high growth) that are packaged around its existing ETF offerings.
But that’s not to say your diversification efforts should stop there. ETFs may form a long term, lower-risk segment of your portfolio. But this can be balanced with some higher risk investments like individual stocks, crowd-sourced funding (CSF) offers, cryptocurrency or even music royalties.