Simply put, ETFs are one of the best instruments that are available to investors today; especially for retail investors like you and me.
If I were to give an analogy, ETFs are like “cai png” (mixed rice) – Cheap and gets the job done whereas your traditional funds are like “restaurants” – Expensive and not very filling.
After this article, you will be able to understand the following:
- What is an ETF exactly?
- Why is it so good?
- What kind of ETFs are out there?
We will not be covering portfolio construction in this article as that is too complex and would require a separate article for itself to do justice to it.
What is an ETF?
ETFs is an acronym for its rather unsexy and uninspiring name: Exchange Traded Funds. The name originates perhaps from its unique feature that it is actively traded in the markets, much like a stock.
The analogy I would give for an ETF is that, if you think of stocks as eggs, an ETF is a basket containing the eggs and being sold together in a bundle.
Being actively traded brings about many benefits, namely, efficiency as well as liquidity. Before ETFs came to the forefront, if you wanted to buy a fund, you had to go through an arduous process that could span weeks (imagine that).
After you bought the fund, you had no idea about how the fund was doing except when the manager sends you their quarterly or annual reports. ETFs have transformed that. Now, you can get a rather efficient price for your holdings at almost any time.
Why are ETFs so good?
We have covered some of the benefits of ETFs already above, however, there are other benefits as well which makes it one of my favourite instruments.
1. Low Fees
Traditional funds charge a huge premium on their management fees, while studies have conclusively shown that most of them don’t even add value. Unit trusts are one of the biggest offenders with their enormous front and back loads (which can be as much as five percent).
The lower the fees, the better. ETFs excel in this aspect with most of them charging fees of less than 0.2 percent.
You would have also learnt that diversification stabilises returns and is probably the only free lunch in obtaining risk-adjusted returns. ETFs provides a cheap and easy way to obtain such benefits.
If you were looking at the small cap US stocks, imagine the tedious amount of effort in going out and buying them in the right proportions (almost 2000 stocks to match the Russell 2000).
3. Ease of obtaining exposure to illiquid asset classes
While most of us will only be familiar with equities, the truth is; equities is one of the smallest asset classes out there. Other asset classes such as currencies, fixed income (rates and credit), alternatives (commodities) are also essential in the investing journey. Diversification does not stop within the asset class, rather it should encompass your entire portfolio.
ETFs allows one to gain exposure to these asset classes at a cost effective and manageable level. Imagine you wanted to invest specifically in property sectors with just $2000, that would have been impossible in the past, but with ETFs, it is realisable now.
To summarise, ETFs are low cost, provides inbuilt diversification and allows one to gain exposure to asset classes that one might not have been able before.
What kind of ETFs are out there?
The universe of ETFs is truly large. However, I have included a few below.
How to invest?
Investing in ETFs is simple. Sign up with a broker (preferably a low-cost one with access to US markets). I personally use interactive brokers as it is reputable and has one of the lowest cost structures across the industry.
To avoid: Any firms with high commission costs justifying that by bundling research costs inside. Frankly speaking as a passive investor, those research pieces will be almost irrelevant to you.
After signing up with the broker, just deposit your funds and type in the relevant tickers of the ETF that you want to purchase and Voila! You have made your first investment.
ETFs offer one the ability to construct a meaningful investment portfolio per your own risk and return preferences. We will cover portfolio construction and its mechanics in another article.
Bonus: You can do it yourself now and gain way better returns than those ILPs that financial agents are constantly trying to sell you.
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