PlusMarkets Analysis • April 16, 2021
ETFs stand for ‘Exchange Traded Funds’ and represent a special type of index fund that uses a computer algorithm to replicate a securities index, usually a stock index such as the S&P 500 or DAX 30. Considering that more and more people are using index funds to invest their money in the stock market, ETFs have gained a lot of popularity recently.
ETFs are special equity funds that enable you to invest your money mostly in company shares. They are particularly convenient for those who are new to trading. As an investor, an ETF allows you to conveniently invest in shares of entire markets or regions – without having to hire a professional fund manager who would charge a lot of money for his work.
An equity fund is a type of basket that contains many different company shares. In other words, instead of investing in one company, you are simultaneously investing in all the companies that make up the fund. This means that your income depends on the performance of all the companies that belong to the fund.
Traditional equity funds, like BlackRock or Fidelity, are usually offered by banks or investment companies that collect money from investors.
Thanks to their broad diversification across company shares in entire markets, ETFs are considered relatively low risk for investors. In other words, when your investment is diversified, the risk is lower because as the prices of the fund’s shares fluctuate, they balance each other out. For example, if the price of company X drops by 20%, but the price of company Y gains 30%, the gains of company Y will have offset the losses of company X.
Additionally, ETFs do not run up expensive management fees because they are not ‘actively’ managed by an individual. Instead, a computer decides the composition of the fund, making ETFs a cheaper investment than a ‘traditional’ fund.
ETFs tend to attract investors who want to participate in the stock market without having to deal with individual shares in detail. They are especially popular for long-term investments as historic data shows us that the values of large stock indices develop positively over longer periods – fifteen to twenty years.
You can trade ETF units on the stock market just as easily as you can trade individual shares, which allows you to react flexibly to changing market situations. This is not easily possible with shares in ‘actively’ managed equity funds, as they often have holding periods.
The most popular ETF in the world is the MSCI World Index. It tracks the performance of the 1,600 largest corporate stocks from 23 industrialized countries, so ETFs that track this index is considered relatively low risk. The same could be said of the MSCI All Country World Index which includes company shares of more than 2,700 of the world’s largest publicly traded companies.
On the other hand, ETFs could be specific to industries or sectors. For example, there are numerous ETFs based on indices that contain shares of particularly sustainable companies such as the MSCI World SRI.
As a general rule, the potential for higher return is always accompanied by higher risk. So before investing, it is crucial to think about the risks you are willing to take.
ETFs are traded on the stock exchange just like shares. In order to buy ETFs, you need a securities account. This is a type of account where securities transactions are processed. This service is offered by banks and, usually at somewhat more favorable conditions, by online brokers. The final choice of ETFs should then be made based on factors such as performance, fees, and, most importantly, the investor’s risk appetite.
Although ETFs have many advantages over actively managed funds, consumers must also factor in the drawbacks before deciding to buy. For instance, when compared to other funds, ETFs are cheaper, but when compared to individual stocks, they are more expensive. Furthermore, there are dividend-paying ETFs, but the yields are not likely to be as high as owning stock directly.
But despite these weaknesses, ETFs perform well and relatively transparently when compared with ‘actively’ managed funds. Their popularity has risen in the last couple of decades as both institutional and individual investors recognize their value.
As a general rule, it’s important to keep in mind that no investment is perfect or risk-free, but learning and identifying the downsides is a good way to protect yourself.
Plus Markets offers a variety of CFDs on ETFs including International ETs, Sector ETFs, and Stock ETFs.
Risk disclaimer: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 71.26% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
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