What is an exchange-traded-fund (ETF) and how does it work? How can you build a successful long-term investment portfolio, without complexity. ETFs are a simple way to invest without needing to unpick complex financial jargon. EFTs can be for everyone and you don’t need to be a day-trader to develop and fine-tune a great portfolio.
An ETF can a portfolio constructed to match or track the components of a financial market index. This would be an index like the Standard & Poor’s 500 Index. This is better known as the S&P 500 index. An ETF that has the intention to mirror the S&P 500 would be an Index Fund. ETFs can vary in how closely they choose track an index or even multiple indices
What Is An Index Tracking ETF And How Does It Work?
Some ETFs may describe their investment strategy as a 70% index tracking. They will then have the flexibility to invest into other assets. This may include transferable securities, collective investment schemes and money market instruments. ETFs may also differ by way of the index they choose to track. There are funds dedicated to tracking one index such as the S&P 500. Another ETF may track a global bucket of index funds. From Emerging Markets to Developed Markets Index Funds, there’s no shortage of indices.
Disclaimer: This is not financial advice and you are responsible for your own financial decisions. When investing capital is at risk.
There are many ETF characteristics and advantages:
In short, ETFs can be index trackers but there is vast complexity in the market segment they track. They can contain stocks, bonds, property, commodities, forex (currency and more). Despite their seemingly complex nature, they are often simpler than you might think. This simple and standardized structure means there are great advantages associated with ETFs:
Low cost
Highly diversified
Flexibility of investments
Ease of tracking against a benchmark
Liquidity (e.g. ease of selling your investments)
Transparency
What Is An ETF & How Does It Work?
It’s easy to get caught up with all the investing jargon. When it comes to understanding what is an ETF. The three things you need to know when it comes to knowing how an ETF works are:
What is an ETF?
How do ETFs work?
How safe are ETFs?
What Is An ETF?
An EFT is usually designed to track a specific segment of the financial market. This means it can contain anything from stocks and bonds to forex and commodities. In essence you can invest into assets ranging from Gold to Apple shares.
ETFs pool together money from all the investors that buy into the fund. This means that you can easily and affordably access these complex assets. You can efficiently diversify your portfolio, without buying whole shares in companies.. This unique feature is what defines an ETF. It’s what is bought and sold between investors on a stock exchange (exchange-traded).
Exchange Traded funds are great for every investors who want minimal fees and tax efficiency. With an ETF there is flexibility with how much and how often you want to invest. Their automated nature also means that you can put your investments on autopilot. It also means that it will dynamically rebalance and maintain your portfolio long-term.
How do ETFs work
The ETF you invest into will continually buy and hold the assets that make up that market segment. You may buy into an ETF fund tracking the FTSE 100. The ETF will use your investment and that of other investors to buy shares in the top 100 companies in the UK. You would buy shares in the likes of Shell, AstraZeneca, HSBC, Unilever.
This all means that you do not need to buy individual shares to invest in lot’s of companies. A £100 investment would be weighted out across the 100 constituents of this index. All depending on their market cap and weighting within the index.
You can invest in an ETF that tracks one particular market segment like the FTSE 100. You can also diversify to a much greater extent. This is because you can select an ETF that tracks global stocks. To do this you would look for a fund like a FTSE All World UCIT ETF or the MSCI World Index. ETFs like this are available with Fidelity, Vanguard and investment apps such as Freetrade, Wombat, and Lightyear.
ETFs offer a low cost way to build a fantastic level of diversify into your portfolios. Whilst there are broad market funds you can also tailor your portfolio to very specific segments of the market (e.g. artificial intelligence).
How Safe Are ETFs?
In order for an ETF to be created it needs permission to list on a stock exchange such as the London (LSE) or New York Stock Exchange (NYSE). This also requires permission for the Financial Conduct Authority (FCA). This means that investing via ETFs is a responsible method of investing.
When a provider wants to create an ETF they have work in cooperation with an Authorised Participant (AP). This would normally be an investment bank with the purchasing power to purchase the underlying asset or market segment the ETF wants to track.
When an ETF provider wants to create an ETF, it has to do so in coordination with an Authorised Participant (AP). This will normally be a large investing institution such as an investment bank, with enough buying power to purchase all the underlying assets that make up the market segment the ETF wants to track.
How Do ETFs Work At Fidelity & Vanguard?
Fidelity and Vanguard offer a wide range of funds. Generally these are much more rigid and clearly defined from the start, so you know what you are investing into. Vanguard in particular is very focused on an passive index investing approach. This approach is a offers a great balance between giving you the flexibility to choose your investment strategy. Whilst you have a diverse array of ETFs to invest in, the complexity has been removed, so you can focus on what matters to you.
This is less time-intensive because you can select an ETF which is tailored to you. You can pick an ETF which has an asset allocation centred around your risk appetite and investment goals. Then you set and forget. For example, I’ve been investing since 2015 and with minimal input have made 40% investment returns (last time I checked).
How To Pick An ETF to Invest In?
Whilst there are thousands of funds to choose from, you can pretty much narrow it down to a handful. I’ve hand-picked 8 funds that make my short-list when it comes to long-term passive investing .
Check them out here.
There is never going to be a good time for investors to start investing but there is a silver lining. Interest rate rises, market sell-offs, recessions and inflation provoke a sense of anxiety in investors. In fact, many are asking if it’s now time to sell-off their stocks. This doesn’t mean that there are not some solid investment strategies you can use. There are always ways you can hedge against market euphoria and dysphoria in the market. ETFs provide a robust and resilient foundation for those wanting to invest in the stock market.
What ETFs Can You Invest In?
With the the world finally shifting to ethical and sustainable companies, there are also ways we can both invest and profit in this change. In fact, there are 7 low cost ESG funds I think will do the trick.
ETFs provide a great long-term investment vehicle for young investors in particular. if you learn some of the basics then this can be very profitable. So, remember to download my 8 favourite index funds.
If you are closer to retirement, this doesn’t mean you can’t invest, you just need to know how to mitigate risk in your portfolio. With this in mind check out my 5 balanced or 5 defensive style retirement funds. As you can see, there’s an ETF out there for everyone.
When investing capital is at risk.
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