Investors who want to benefit from expanding global markets use ETFs as their vehicle.
Investors who want to profit from the expansion of global markets use exchange-traded funds (ETFs) as their vehicle. ETFs are accessible and transparent funds that allow you to diversify between equities and other asset classes with an ultra-low cost in terms of time and commissions. Investing ETF : what it is and how to invest
The three main advantages
- Wide diversification: you can quickly get exposure to the most innovative, competitive, and profitable companies on the planet.
- Expenses are reduced to a minimum: competitive pressures in the ETF space keep rates low so that more of the profits end up in your pocket.
- Transparency: ETFs are listed on the main European stock exchanges. This means that with ETFs, you know exactly what you are buying, how it works, and the risks.
ETF: single proposal for sale
For example, the IBEX 35 is the reference stock market index of the Spanish stock market. For its part, the S&P 500 follows the 500 most important public companies in the United States. An ETF that follows the S&P 500 is designed to offer the same (or almost the same) return as that group of major US securities. So when you buy an S&P 500 ETF, you buy a part of the performance of the most powerful companies in the United States, such as Apple, Amazon, Alphabet, Microsoft, Tesla, etc.
But instead of incurring the stress of buying the 500 shares, in addition to trading to maintain the same hierarchical order as the index, you can subcontract all the work to the ETF. The ETF management team has a single objective: to follow the index. This means you know exactly what the investment is doing and can follow its index. And no, for example, secretly taking more risks than you are comfortable with. In addition, since there is an ETF that covers all imaginable markets, you can execute any investment strategy you want.
ETFs: what are they, and how do you invest in them?
ETFs are stock-exchange-traded investment funds.
That’s why it’s termed a listed or exchange-traded fund. ETFs have become very popular because they combine two of the best qualities of stocks and funds.
The liquidity and flexibility of trading stock with the simplicity of a fund that lets you invest in hundreds or thousands of assets with one investment vehicle
This diagram illustrates ETF characteristics:
How do ETFs work?
Your money buys shares of the fund. The number of shares purchased is equal to your contribution divided by the share price of the ETF (after the trading expenses charged by your platform). Your money joins the contributions of thousands of other investors in the fund.Investing ETF : what it is and how to invest
This capital injection finances the purchase of the underlying securities of the ETF. Normally, these are the same securities that make up the index that follows the ETF.Your shares in the ETF entitle you to participate in the fund’s profitability. Its results depend on the underlying values that replicate the profitability of the index.
- If the S&P 500 earns 10% in a year, the value of your participation in the ETF should be around 10%.
- If the S&P falls by 10%, your ETF should also fall by approximately 10%.
Two aspects are worth mentioning.
- First of all, your real return is always what is left after the commissions. In the previous example, your profitability would be 10% minus 0.07% of management fees in the case of an S&P 500 ETF. Therefore, the profitability after commissions would be 9.93%. Every investment carries commissions. ETF commissions are modest and transparent, unlike less regulated assets, which impair profitability through hidden expenses.
- Secondly, ETFs do not always have all the values of the index. Many indices are made up of small and illiquid securities that are expensive to trade and make a negligible difference in overall profitability.
Ultimately, you can know if your ETF is doing a good job replicating your index by checking that its annual return approximately coincides with the annual return of the index. A well-managed ETF offers the profitability of the index minus management fees. You can easily check it through justETF in the ETF profile.
Five reasons why the demand for ETFs is growing
- All major asset classes are available with ETFs, from stocks to the real estate sector, including fixed income and commodities. You can quickly build a solid investment strategy with just a few investments.
- Dynamic competition between ETF providers results in lower costs for consumers.
- You are protected if the ETF provider breaks down: the investor’s assets are legally separated from those of the investment company. This means that your assets were sold at market value, and I would refund your money if the ETF provider declared insolvent.Each ETF discloses the index it tracks and publishes a daily list of shares that can be compared to the index.
- ETFs are widely available through all good investment platforms and are easily traded during stock market hours.
This contrasts with the situation of active management funds. Active fund managers are usually opaque in terms of their shares. An active fund’s risk level can and often does drift into riskier territory. This often happens because managers are pressured to achieve disproportionate performance goals systematically.
Very few managers can sustain long-term profitability to justify their exorbitant compensation.
After a few years of outperforming the market, some will slip off the scoreboard. It is a well-known phenomenon that financial academics have repeatedly demonstrated and that the SPIVA classification supports.
In comparison, ETF managers have no pressure to beat the market. They earn by obtaining the profitability of their index after commissions every year. This consistent and low-cost approach has proven to be remarkably effective and is another reason why even the main financial actors have turned to ETFs.
The popularity of large ETFs makes them extremely liquid. This further reduces commissions by decreasing the differential between supply and demand in operations. Other market innovations, such as commission-free trading, make the total cost of ownership even cheaper.Investing ETF : what it is and how to invest
Why haven’t I heard about ETFs before?
ETF suppliers don’t pay commissions, thus financial advisors and connected banks don’t promote them.
The financial media doesn’t advertise ETFs since they’re cheap.
ETFs are not publicized, thus they don’t appear in financial news articles about superstar managers, megatrends, and stunning market swings.
The result is that ETFs have remained relatively unknown among the general public. At the same time, they quietly gain status among financial institutions, advisors who only charge fees, and equally knowledgeable private investors. Even the strongest pension funds and insurance companies now use ETFs as fundamental portfolio investments.Investing ETF : what it is and how to invest