What is an ETF and how can you invest in one?

Estimated reading time
 5 min

Learn all about

• What an ETF is and how you can invest in them
• The different types of ETFs
• Some of the pros and cons of investing in ETFs
• How to mitigate loss aversion when investing

Excited to kick-start your investment journey, but not sure where to start?

Welcome to the world of Exchange Traded Funds (ETFs) – generally regarded as a lower-cost and lower-risk option that can help you get your foot in the investment door.

Remember, always do research before investing. Read the T&Cs and product information, find out more about the risks and benefits and consider any fees and charges. You might also want to consult an advisor to get independent financial and tax advice for your circumstances.

So, what is an ETF?

ETFs can seem like a complex investment type, so we’ve broken it all down for you:

• An ETF is a group of assets owned by a third-party (like an investment management company). Some of these assets might be stocks, bonds, commodities (everyday goods like gold), or currencies.
• When you invest in an ETF, you won’t own the group of assets in the fund. Instead, you’ll own the units in the ETF, which is a portion of ownership in the fund. The number of units you own will reflect how much money you invested to begin with.
• To start investing in ETFs, you or a stockbroker will need to buy units on an exchange, like the Australian Securities Exchange (ASX) or Cboe Australia (CXA).¹
• The goal of your ETF is to either reflect the value of the financial market or outperform it – it will depend on the type of ETF you invest in.

  Hot tip:

If you decide to buy and sell ETFs through a stockbroker, then you’ll have to pay some fees if you go down this route (usually a percentage of the ETF price or a flat brokerage fee). So, it’s important you incorporate these fees into your budget if you decide to invest in an ETF through a broker. There might also be fees if you decide to buy or sell ETFs yourself – it pays to do your research.

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What are the different types of ETFs?

1. Passively managed ETFs

A passively managed ETF is when you invest in a group of different investments that represent part of the financial market (called a ‘market index’). This type of ETF aims to reflect the market value as close as possible, instead of outperforming it. So, if the market value increases, your passively managed ETF can increase in value too. The reason why it’s ‘passively managed’ is because you or your stockbroker will buy the ETF and passively watch it match the market value, rather than actively try to outperform it.

2. Actively managed ETFs

Actively managed ETFs are controlled by a fund manager. They will buy and sell investments regularly to try and make your ETF outperform the financial market. So, if this type of ETF performs better than the market (instead of just matching it in value), you can earn more than what you initially invested – but it’s not always guaranteed that this type of ETF will outperform the market. Your fund manager might use a combination of low and medium-risk strategies or go hard with a high-risk strategy instead if that’s more aligned with your investment goals.

3. Physically-backed ETFs

A physically-backed ETF is when a fund manager buys all, or part of, the physical assets you’re investing in, like precious metals. For example, a physically-backed gold ETF will physically hold the gold bars in a secure location while your ETF tries to match their performance on the market. Using the gold ETF example, if gold does well on the market, then your ETF value will increase, and your fund manager can sell the ETF to earn you a profit.

What are some of the pros and cons of investing in an ETF?

• Pro: Your portfolio is diversified (spread out across different investments) and isn’t as risky as other investments. This is because the risk of loss is also spread out across multiple investments, rather than putting all your eggs in one basket.
• Con: The success of your ETF relies on the market or sector it’s tracking. If the market or sector drops in value, the value of your ETF investment will also drop.
• Pro: There’s a lower cost to getting started, which can be a smart move for beginner investors. The amount you’ll need to buy an ETF will depend on what you want to buy, but they can sometimes be as little as $1 depending on your stockbroker.
• Con: If your ETF is invested in an international asset, then the currency conversion might impact your returns.
• Pro: ETFs are quite transparent about their value, as they publish their net asset value (NAV) at the end of each day. The NAV is a dollar amount per share that can give you an indication of an ETF’s current value.
• Con: The buying or selling price of an ETF can fluctuate, which means your ETF might not be at its ideal value when you buy or sell. The difference is usually small, but it’s still important to keep in mind when investing in ETFs.

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  Brain hack

When it comes to investing, you might feel the pain of losing money more than you’d feel the joy of earning the same amount. This feeling is what we call loss aversion which is when the pain of losing is twice as powerful as the satisfaction of gaining. When you invest in ETFs, there’s a chance that you might lose money – but there’s also a chance you could earn more than you initially invested. To reduce the impact of loss aversion when investing, have a solid investment strategy that reflects your risk appetite and clear goals. The strategy can help you work out what investment types are ideal for your situation, while the goals can keep your eye on the prize.

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