Exchange-traded funds are one of the many ways you can make your money work for you. In the aftermath of the pandemic, interest in the stock market and other investment methods has increased. If you are new to investing, exchange-traded funds (ETFs) can be a low-cost alternative to different investment types.
However, all financial decisions come with pros and cons. Whether it’s no credit check loans, loans for people on Centrelink, buying a home, or entering the world of cryptocurrency investing, being aware of all the possible outcomes will benefit you. Hence, this will be an introductory guide to exchange-traded funds and other elements of making your money work for you.
Please note that specific ideas and products presented in this article may not be on offer by Monzi or the lenders we work with. This article presents only general information. Consider seeking professional financial, taxation, legal or other advice to check how the information and ideas presented on this website relate to your unique circumstances.
What are exchange-traded funds?
Exchange-traded funds are small, passive investment funds that are composed of several shares or assets. ETFs are a low-cost alternative to other investment types and share some similarities with index funds and commodities. ETFs have recently risen in popularity because they allow a new investor to invest in multiple shares at once. This, thereby, enables investors to diversify their portfolios quickly.
There are several available options on the Australian Stock Exchange (ASX) regarding the funds you can choose from. Typically, the ETF you choose will be a mixed bag of cash, bonds, and shares. These ETFs can be bought and sold in the same way you would buy and sell regular shares. The extent of the asset classes available within various ETFs is significant, allowing you to lower your risk through a diversified portfolio.
How do exchange-traded funds work?
For Aussies, an exchange-traded fund is a small group of assets that you can buy and sell on exchanges such as the ASX. Note that you can engage with any exchange you like, although you may find the ASX more regulated and potentially safer than other options. ETFs won’t enable you to outperform the market, but rather their value will increase or decrease with the asset or index they are tracking.
Keep in mind that exchange-traded commodities, notes, certificates, and securities are not ETFs. They may look very similar to exchange-traded funds, however. Therefore, it may be wise to be as transparent as possible about what you are looking to invest in. If you are unsure what you are doing, it may be worth taking the extra time to inform yourself. Or to engage with a fund manager to help you better understand where to put your money. Having a fund manager there to help is likely to increase your chances of meeting your financial goals. Even if you are only investing a small amount, there is still the potential for loss.
Types of ETFs
There are several types of ETFs on the Australian Stock Exchange and various other exchanges that you can engage with. However, most exchange-traded funds fall into one of two categories: Physically-backed ETFs and Synthetic ETFs. Regardless of the type of ETF, you will own the units, and the ETF provider will own the assets or shares.
Synthetic exchange-traded funds don’t hold physical assets. Instead, they essentially work to copy an index or asset’s movement. Some good examples of synthetic ETFs are commodity ETFs or gold. There’s no physical gold but rather a contract that generates returns based on the direction of gold’s price.
Physically backed ETFs:
Physical exchange-traded funds, on the other hand, allow you to purchase the underlying assets. Either as a sample of the securities in the index or all of the securities.
Why would you want exchange-traded funds?
One of the key motivators for seeking out exchange-traded funds is inexperience. If you are young or inexperienced in investing, ETFs can simplify the process of building a diversified portfolio. Not only this, but they are also relatively low-cost in most instances and boast quite a low risk. It makes more sense to start with an investment option that is unlikely to turn around and hurt you rather than jumping right out of the gates into the deep end.
In general, however, there are five main reasons why you might want to invest in ETFs. These are:
- Low fees
- Keeping up with growth
- Available investment management options
ETFs can allow you to keep your investments up to date and relevant, without the attached risk and high costs.
How to invest in exchange-traded funds?
One of the easiest ways to buy and sell units within an ETF is via a stockbroker, just as you would with shares. However, one of the best places to start when it comes to investing in ETFs is to compare the ASX price with the Net Asset Value (NAV). This NAV of the units within the ETF is imperative to ensure that you are buying a reasonably priced ETF off the ASX. Net asset value allows you to create a reference point for your buying and selling.
From there, consider the timing of when you are looking to buy. Doing your research into how the market works is a great way to ensure you get the best value for your money. Finally, before you invest, ensure you check the relevant product disclosure statement (PDS). This statement will tell you the following:
- The associated risk
- What asset, index or sector the ETF will try to replicate
- The associated costs
- How to report a problem with the ETF
Any questions about the ETF you are looking to purchase can usually go to the fund manager. Alternatively, seek help from a financial advisor.
Exchange-traded funds vs index funds
Both index funds and ETFs are similar and offer good opportunities for young investors, but what are the differences? And which one should you choose? Well, firstly, out of all the components of each option, they both share the following features:
- Strong long term returns: If you are looking to play the long game, investing via either option is likely to generate positive returns as time progresses.
- Low cost: As both of these options are passively managed rather than actively managed, you may not have the associated costs of a broker.
- Diversification: An index fund and an ETF are both a bundle of individual investments that come together to form a single investment; allowing you to diversify your portfolio easily.
While actively managed funds may generate better returns, index funds and exchange-traded funds may be better depending on where you are at with your portfolio and experience. The differences between the two, on the other hand, include:
- The minimum required investment: ETFs typically require a lower minimum than an index fund. This isn’t always the case; however, it is more common.
- How you buy and sell: ETFs trade through the day like regular stocks. On the other hand, index funds can only sell for the set price at the end of the day.
- The expense of owning them: ETFs and index funds are low-cost from the expense ratio perspective. However, index funds typically cost more to buy and may be associated with various transaction fees.
- Capital gains tax: ETFs might be the best choice for you if you are looking for a more tax-efficient option. Consider the tax that might apply before buying any investments.
Various options will work better for some people than they will for others. Consider your position before making your decision.
Green exchange-traded funds
You may be surprised to hear that the bulk of ETFs, and investments in general, are not so great for the environment. Luckily, there are several ethical exchange-traded funds. You can locate a handful of these on the ASX without requiring you to look too hard. However, many of these companies may not be as green as you might hope they would be. This is as some of these companies still engage with fossil fuels.
Fortunately, it can be easy to obtain information on the operations of these companies if you are looking to be more eco-friendly. Not only this, but you may also be able to view various comparison tools that can highlight the features of these green ETFs. These are easy to find with a simple google search. Once you find a site offering one, the tool will show you a side-by-side comparison of the available ETF options. Not all of these providers will be green. However, it will illustrate the name of the company, brokerage on Aussie EFTs, whether there is an inactivity fee, and the markets they are available on.
Once you narrow down your options, you can then do further research on the provider itself to determine whether their exchange-traded funds are green and environmentally friendly.
What are mutual funds?
When it comes to ETFs, another term you may have heard of is mutual funds. Mutual funds are essentially a pool of money from various investors that is used to purchase bonds, stocks and assets. There are two types of mutual funds, active and passive. Index funds and exchange-traded funds are two examples of passive funds. Whilst passive investing can be quite a slow option, it may be more likely to generate stronger returns. Stocks and bonds that don’t pool together are some examples of active investments and offer more risk.
Generally, there are four active mutual fund types: stocks, which carry the most significant risk and room for potential returns. Balanced funds – also called hybrids – mix stocks, bonds and other securities and invest in a group of additional mutual funds. Bond funds are similar to stocks; however, they come with less risk. Talking to an investment broker is an excellent way to determine which type of active funds may work best for you. However, passive funds can be a better choice for new investors.
What are open-ended mutual funds?
ETFs and index funds are also examples of open-ended mutual funds. This means that as more investors buy into a specific fund, more units may become available. However, the downside is that even though new investors can enter and add units, they can also leave and cancel the extra units. Investor activity and investment returns have a significant influence over how well these mutual funds perform.
Alternatively, you can also invest in closed-ended mutual funds. These are investments where the number of units/shares on the market is fixed. The amount of investor interest will have no sway over how well this mutual fund performs. The market sets the price of the unit. This information may not be highly relevant for a first-time investor. However, it is worth having a basic understanding of how the ASX determines prices.
What is a gold exchange-traded fund?
As given in the previous example, Gold ETFs are exchange-traded funds that track the domestic physical gold price. These ETFs are synthetic, and you can purchase them from a stock exchange. As with most ETFs, gold is a passive investment based on the current gold prices, and you may receive it in paper or dematerialised form.
This is more convenient for several reasons. For example, these exchange-traded funds allow you to access gold without the attached security risks, storage costs and markups. Holding physical bullions of gold does sound enticing. However, it puts you at a much higher risk of theft and may be more expensive than simply possessing the ETF.
Can you short sell exchange-traded funds?
The act of simply buying an ETF is typically ‘going long’, a long term investment that you may intend to purchase and not touch again. On the other hand, there is the option to short sell ETFs, also known as ‘shorting’. There are a plethora of reasons you may want to short sell ETFs. The first is to take profit. You may likely purchase an exchange-traded fund and have the price significantly increase. If this does happen, you may choose to close the position and lock in your gains. Or, perhaps you could sell some or all of your ETF for profit.
Some more advanced options may be worth researching further. These include hedging downside risk, hedging trading positions, or gaining downside exposure. These alternatives are for the experienced investor and can be learnt about as you progress with your investing knowledge. However, if you do wish to short sell, the simplest way to do so is by placing a sell order with a broker and buying an inverse ETF. The concept of short selling is difficult to comprehend, but you can master it with the appropriate research and dedication.
What is the best ETF in Australia?
It is not for Monzi to say which ETF is the best in Australia. However, many of the ETFs on the ASX are there for a reason. For a new investor, looking into the options available on the ASX may be an intelligent choice. However, as stated earlier, there are ways to compare the available exchange-traded fund options. These are with a comparison tool. You can find such a tool by simply searching for an ‘exchange-traded funds comparison tool’ online. Whilst this won’t show you the best ETF in Australia, it will give you comparisons of some of the options available to you. This allows you to pick out the ones that intrigue you and conduct further research into them.
Speaking of tools that make life easier, Monzi’s lender-finder would have to be one of them. Monzi can help match you with one of the lender’s in our network in potentially as little as 60 minutes. Not only this, but the Monzi lenders know that life doesn’t always go so smoothly. For this reason, they may be able to offer you bad credit loans or other small loans that are lenient when it comes to your credit score. If you need quick loans now, our process couldn’t be more straightforward, and our friendly team is ready to help with any questions you may have.
ETFs vs stocks
As with most points so far, ETFs and stocks have their similarities. However, the best way to put it is that you’re investing in a single company, like Woolworths, when you purchase stocks. Whereas when you buy exchange-traded funds, not only might you get some Woolworths stocks, you might also get some Bunnings stocks and a small amount of Event Cinemas bonds. This is theoretical, yet it helps illustrate that ETFs are a mixed bag; you get a certain amount of units from each retailer.
ETFs make it easier for you to be more successful in the long term because you get a collection of different stocks, bonds, or shares. This reduces your risk by diversifying your portfolio. Whereas with stocks alone, you are simply picking one company to back and essentially flipping a coin as to whether or not you will be successful.
Are exchange-traded funds safer than stocks?
It is easy to view exchange-traded funds as being safer than stocks, which in a sense might be true. However, this does not mean that ETFs are risk-free themselves. Investing is all about how much risk you are willing to take. You may be able to find relatively safe and stable ETFs that you can sit on for the long term. However, it is also possible that you can locate higher risk exchange-traded funds.
Stocks, on the other hand, can display more volatility depending on the state of the economy. However, if you pick the right stocks to invest in, there is also more potential for higher rewards. There are safer options within stocks, too. For example, you could invest in a corporate giant with a market monopoly and rest easy knowing it is unlikely this company will tank. Or you could purchase the stocks of an up-and-coming company and invite the volatility in favour of potential reward.
It can be a gamble when it comes to buying and trading on the stock market. Ensure you inform yourself before doing so. The government’s MoneySmart site has an excellent page on exchange traded funds (ETFs) that may be a great place to continue your research. If you find yourself developing any sort of addiction to investing, it may be worth speaking with a financial advisor.
Pros and cons of ETFs
Before engaging with exchange-traded funds, it is a great idea to have a solid grasp of the attached pros and cons.
- Easy to trade: You can buy or sell whenever the exchange is trading.
- Diversification: One of the fastest and easiest ways to expand your portfolio.
- Transparent: The net asset value (NAV) for ETFs is published to the ASX daily.
- Cheap: As ETFs have a low management expense ratio (MER), they can be more affordable than the alternatives.
- Liquidity risk: Some of the assets within ETFs aren’t liquid, meaning redeeming securities can become difficult.
- Currency: If you invest in a foreign market, currency translation may impact your returns.
- Tracking errors: Prices can distance themselves from index value. Meaning it may be wise to buy or sell when it’s not at the NAV.
- Sector risk: The market or sector could decrease in value, taking your investment with it.
Once you learn more about investing, it is easier to want to invest more. This means that you could find yourself exploring the opportunities that come with an investment loan. You can take a loan for all manors of investments, whether it is for an investment property, the stock market, or cryptocurrency investing. Whether you take investment loans or margin loans is up to you. However, you can also take same day loans for the same purpose in some instances.
If this is something you are interested in, why not see how Monzi can help. By attaining a personal loan through one of the lenders in the Monzi network, you might be able to put this loan towards whichever investment needs you may have. Not only this, but our lenders may be able to work with your credit report without immediately writing off your application if you have bad credit.
Is it wise to borrow to invest?
Having said this, is it wise to borrow to invest? Well, the answer to this depends on how smart you are with both your borrowing and investing. This is as you are doubling your risk by doing so. Not only will you have the potential room to make a loss with your stocks, but you will also have a loan to repay on top of this. Therefore, instead of simply losing money to your shares, you will also be in debt simultaneously.
This is especially the case with margin loans where you borrow to invest in the stock market. And with a mortgage loan where you intend to flip a house and resell it. If you feel the need to take out a loan and invest the money, you should be extremely careful about how you invest. It may also be worth seeking the help of an investment broker to ensure you are making the right moves to avoid the potential of a loss.
Can Monzi help with exchange-traded funds?
Monzi cannot help you with your exchange-traded funds. However, there is the potential that you could use personal loans as investment loans. Regardless, no matter what use you have for small loans, the Monzi lender-finder may be able to help you out.
If you’re ready to apply for a loan, Monzi makes it easy. We’re 100% online and paperwork free, and if you apply within business hours we may be able to find you a lender in as little as 60 minutes. To get started, simply click the purple ‘apply now’ button, or scroll to the top of this page to use our loan slider. From there, the application process couldn’t be more straightforward.
Don’t apply just yet if you still have questions that need answers. The Monzi team are ready and waiting to help you with your queries. To chat with a member of our friendly team, simply email us at email@example.com.
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