WTF is an ETF? Exchange-traded funds explained
Don't know what ‘ETF’ stands for? You’re not alone. Letʻs take a quick look at what exchange-traded funds are, and some potential benefits of investing in them!
The world of finance seems to speak another language. For every basic investment term there are thousands of jargon-heavy acronyms.
We want to help translate these terms, so you can feel right at home when talking about your investment portfolio. And we thought exchange-traded funds (ETFs) were a good place to start!
So … what exactly is an ETF?
Let’s start with a bit of background into investing.
First, shares. When you buy shares, you invest in a particular company like Xero or Facebook. Shares can be bought or sold between people on an exchange.
An exchange is a market where people can trade shares. An example of this in NZ is the New Zealand Stock exchange (the NZX). On an exchange, someone wanting to sell shares sets how much they want to sell them for, and someone wanting to buy shares sets how much they want to buy them for—when it’s a match, the shares change hands.
Another way to invest is through mutual funds. Instead of investing in one company at a time, you join a pool of people and spread your investment across a range of things. This is managed by a fund manager and any buying or selling goes through them.
KiwiSaver is an example of a mutual fund. Our money is all pooled together and invested on our behalf, by a fund manager.
This leads us to ETFs. ETFs are like mutual funds—they’re a group of different assets, rather than one particular company. But theyʻre a fund that trades (like shares) on an exchange.
A fruity example
Imagine you go to a market and buy some fruit. Buying individual fruit is like buying shares. You pay the price for each piece of fruit.
An ETF is like buying a basket of fruit. You get all the different types, and they can be grouped by a theme—like colour or season.
What are the benefits?
Diversification—you may have heard the advice ‘don’t put all your eggs in one basket’. When you invest in an ETF you own a piece of a range of assets, instead of just one company.
Accessibility—ETFs open the share market up to a wider audience. They allow people with lower amounts of money to access the same investments as private portfolio clients. They also give access to international investments that can otherwise be difficult.
Lower fees—ETFs tend to have lower fees than other types of investments. In New Zealand they have tax benefits for many as well.
Transparency—you get to see the prices every day.
Liquidity—because they’re traded on an exchange you can sell your ETFs whenever there are interested buyers.
Some facts about ETFs
They’ve been around since the 1987 stock market crash as a tool to help reduce volatility in the market.
They’ve been called ‘instruments for social economic change’ as they allow people to invest in themes.
The UN helped to start low carbon ETFs to support investment into low carbon companies. There is even an ETF that helps promote gender diversity in business (SHE).
If you have any more questions about ETFs that we haven’t covered here, let us know!
Ok, now for the legal bit
Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written. You should consider seeking independent legal, financial, taxation or other advice when considering whether an investment is appropriate for your objectives, financial situation or needs.