What is an ETF? Probably you may have seen or heard about this acronym several times from financial media or experts and want to understand more about it? If so, you are in the right place. We will explain you why investing through an ETF could be a financial life-changing advice. Let’s dive into it…
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What is an ETF?
Exchange traded funds (ETFs) are investment funds that are traded on stock exchanges, much like individual stocks. ETFs are designed to track the performance of a specific index, such as the S&P 500, or a specific sector of the market, such as technology or healthcare.
As an analogy, an ETF is like when you go to a restaurant and you order the ‘menu dégustation’ which will include a bit of the all the specialities. It will allow you to taste a small portion of each option in the menu without ordering all of it. So an ETF is a representative sample of each value included in the index or asset class that you are buying.
Understanding what is an ETF is essential for anyone looking to invest in the stock market with low effort & cost and large diversification.
How ETF works?
ETFs are traded on stock exchanges, just like individual stocks. They are created and redeemed in large blocks of shares called creation units. Authorized participants, typically large financial institutions (like Blackrock, Invesco, Amundi…), can create or redeem creation units by exchanging a basket of underlying assets for shares of the ETF or vice versa.
Investing through ETFs enable you to invest in an entire market with only one security. For example, with a single MSCI World ETF, you spread your investment over the best 1,600 companies from all over the world. Same applies for other indexes as CAC40.
In addition to equities, you can also invest in many other asset classes with ETFs. Owing to this variety, ETFs are the perfect building blocks for private financial investments. It simply copy a market index one-to-one and can be traded at any time on the stock exchange like a share.
ETFs vs Mutual Funds
ETFs offer several advantages over mutual funds, including lower fees, greate
r liquidity, and the ability to trade throughout the day. They are also more tax-efficient than mutual funds because they have lower turnover and do not distribute capital gains to investors.
For you to understand, a Mutual Fund fee would be around 1 to 3% a year. It is normal as the issuing institution will need to spend resources analyzing companies, markets, and many variables in order to pick the best values as per their strategy.
In the other hand, ETFs fees are from 0,16 to 0,6%. There is no much effort to select the stocks or values part of it as is already defined by the index itself.
And guess what? ETFs has much better returns than funds! 92,19% of funds has underperformed the S&P 500 Index This has been demotrasted by the SPIVA study:
To conclude, buying an ETF makes sense for individuals looking for an easy and efficient way to follow the market performance. Buying a fund could make sense when you want to invest in an specific theme (like AI, green energies, etc.).
Investing in ETFs
Investing in Exchange Traded Funds (ETFs) can be a great way to diversify your portfolio and gain exposure to a wide range of asset classes, sectors, industries, and international markets. Here are some things to consider when investing in ETFs:
Choosing the Right ETF
Before investing in an ETF, it’s important to do your research and choose the right one for your investment goals. You can use a screener to filter ETFs based on criteria such as asset class, sector, industry, expense ratio (annual fee), and performance.
An important point to check is the index replication type: Physical replication, sampling, or swap. We do prefer physical replication as it implies that the financial institution that issued the ETF is actually buying proportionally real values of all the companies behind the index.
A sampling method will exclude some values / stocks from the index. If swapping, it means the ETF provider is not directly buying the real stock values, but similar ones and then swapping through a 3th party. This is a financial engineer trick but implies a bit more of risk.
You should also consider the ETF’s distribution policy: dividends accumulated or distributed. If you read ‘ACC’ in the ETF name it means that dividends generated by the companies belonging to the index are reinvested within.
Accumulating dividends makes sense for long term investors as you do not pay taxes from those dividends reinvested.
In the other hand, if it says ‘DIST’ means that the ETF will pay you dividends (normally every quarter or year). In this case, you will be entitled to pay taxes on those dividends. Choosing this kind of ETF could make sense for those looking for passive income.
A last key point to check is the fund size. An ETF with less than 50M€ may not be liquid enough. Meaning that when you want to sell, maybe you will not find easily buyers or vice versa. It could generate an spread cost for you. We prefer funds with more than 500M€ invested.
ETF Trading Strategies
There are different trading strategies you can use when investing in ETFs, such as dollar-cost averaging, market timing, and rebalancing.
Dollar-cost averaging involves investing a fixed amount of money in an ETF on a regular basis, regardless of market conditions.
Market timing involves buying and selling ETFs based on market trends and economic indicators. This is close to speculation and very risky.
Rebalancing involves adjusting your portfolio periodically to maintain your desired asset allocation. If a given ETF has performed great, you may want to sell a bit to buy another one that is currently cheap.
Benefits of investing in Exchange Traded Funds or ETFs
One of the main benefits of investing in ETFs is portfolio diversification. ETFs can provide exposure to a variety of asset classes, such as stocks, bonds, commodities, and currencies. They can also provide exposure to different sectors, industries, and international markets.
By diversifying your portfolio with ETFs, you can potentially reduce your risk and increase your returns.
Buying an index such as the CAC40 in France, will be a guarantee for you to be invested all the time in the largest companies of the country.
As example, the companies that were leaders 10 years in the market may not be today. In the past, Oil and Telecom companies were leaders, today is more Luxury and Technology.
Another key advantage of ETF’s is that it provides investors with a low-cost, tax-efficient way to gain exposure to a wide range of securities. This is why you will never hear your bank agent or a (non fully independent) financial advisor proposing you to buy an ETF.
Finally, ETFs are less volatile than holding individual stock. It is enough a bad news about one company to see their value crashing -5% or more during 1 day. This is strange with ETFs.
How to buy an ETF?
Once you have selected the ETF you want to buy, then you can buy from a broker account. If you do not have one, read our blog about best broker accounts in France.
From your broker account, you can search your preferred ETF from the search bar. However, as not all ETF are available from all brokers, and to avoid selecting the wrong one, it could be wise to directly search by using its ISIN or ticker code.
Here an example of the ETF iShares Core MSCI World UCITS ETF USD (Acc), ISIN IE00B4L5Y983 | Ticker EUNL.
Another key point of attention will be to select the stock exchange from where you want to buy it (for example London LSE, Xetra from Germany, Euronext Amsterdam, Nasdaq, etc.). You may need to select the currency that you want to buy the ETF (USD, EUR, CHF, etc.).
You can read our blog about how to buy stocks online to learn more.
- ETFs are investment funds that are traded on stock exchanges and designed to track the performance of a specific index or sector of the market.
- Investing in ETFs is an effortless way to profit from market growth.
- ETFs offer investors (at low-cost) exposure to a diversified portfolio.