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Exchange-traded funds (ETFs) are an increasingly popular investment option for investors looking to diversify their portfolios.
ETFs are a type of investment fund that track an index, a commodity or a basket of assets. From there, the ETF either tries to replicate the performance of the relevant index or asset, or to outperform it. They offer a way to gain exposure to specific sectors, asset classes and markets without having to buy each underlying security individually.
4 benefits of ETFs
ETFs have become increasingly popular because they offer investors the chance to benefit from the performance of a wide range of investments in one product.
First, an ETF typically only has a small management fee associated with it, which makes them attractive when compared with actively managed mutual funds that tend to be more expensive.
Second, since ETFs often track an index, they may be less volatile than individual stocks over the long term as their performance is more closely linked to the overall market rather than any single stock’s performance.
Third, they can often be bought and sold like stocks on stock exchanges while still providing access to complex investments such as foreign currencies and commodities. This provides investors with greater flexibility and liquidity than other types of investments, such as hedge funds.
And finally, ETFs can provide access to certain markets which would otherwise be unavailable due to geographic restrictions or prohibitive costs involved in trading the underlying securities. This makes them particularly useful for international investors who want to invest in foreign markets without having to pay large commissions or convert currency each time they buy or sell securities.
Examples of ETFs on the ASX
There are ~240 ETFs listed on the ASX.
All these funds track different indices or sectors – some replicate indices exactly, others try and beat indices by overweighting exposure to particular stocks, others try to achieve the opposite of what the index is doing.
An example of the latter was best performer of 2022 Betashares US Equities Strong Bear Fund (ASX:BBUS). It gained 19% because the S&P 500 fell 19%.
Just behind it was BetaShares Global Energy Companies ETF (ASX:FUEL). This fund profited from skyrocketing oil and gas prices in 2022 and, therefore, the share prices in the companies it owned.
Conversely, one of the worst performing ETFs was the BetaShares Crypto Innovators ETF (ASX:CRYP), which shed over 75%. Although it does not invest in crypto assets directly, it invests in companies building crypto infrastructure and they suffered during the Crypto Winter.
Investors need to consider the risks
As you can see above, ETFs may be perceived as lower-risk investment, but this is not necessarily the case. Therefore, it’s important for investors considering investing in ETFs to understand the risks associated with these types of investments.
The most significant risk comes from tracking errors where the performance of an ETF does not match up exactly with its benchmark index or basket of assets.
Additionally, when compared with actively managed mutual funds, there is no guarantee that you will make money by investing in an ETF. Its performance will depend largely on the health of the underlying market it tracks.
Any investor simply investing in an ETF because of its name is not doing enough due diligence – as a bare minimum, they need to see what companies, commodities, FX or Crypto the fund is investing in.
ETFs are an attractive investment option
Overall, we believe ETFs are an attractive investment option for investors. They offer access to different asset classes and markets without having to manage multiple accounts or incur high fees and commissions associated with some traditional investments, such as active mutual funds or individual stocks outside your domestic exchange.
As always though, do your own research on potential investments carefully before allocating your hard-earned capital to any ETF!
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