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What is an ETF?

By Antonia Medlicott

  • Published: April 28, 2024
  • Edited by: Clare West
  • Last Update: 2 weeks ago
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An overview


So you’ve come across ETFs but are unsure exactly what an ETF is, or indeed whether it's a good option for you to invest in.

When it comes to investing, you can pick your own individual stocks, however, that requires a lot of research to get right, and a significant change to one stock can have a massive impact on your returns if you haven’t diversified your portfolio correctly.

An ETF (Exchange Traded Fund) is a basket of assets that can include stocks, gold, real estate, and bonds to name a few. These are all pooled together so that individual investors can buy shares in the basket. By buying shares in the basket, you are actually buying a tiny slither of each of the assets contained within that basket.

ETFs are usually managed by a professional, who will constantly monitor and adjust the assets held within the fund. The fund is traded on a stock market, just like any other asset, hence the name Exchanged Traded Fund. This means you can buy or sell shares in an ETF throughout the trading day, and the price of the ETF can go up and down based on the performance of the assets held within the fund.

What are the advantages of investing in an ETF?


There are several advantages to investing in ETFs, especially for those new to investing. They are low-cost, provide instant diversification, and are easily accessible. They also allow investors to own a share in assets they might not otherwise be able to afford.

Possibly one of the most compelling reasons to consider an ETF is how easy they make investing. They are considered passive investments, meaning they can mirror an index (for example the S&P 500) without the need for much human intervention in selecting the assets within the fund. This is what makes ETFs so cheap to manage, and cheap, therefore, to buy.

In addition, because ETFs are traded like stocks, they benefit from the same options when trading, such as ‘stop orders’ or ‘limit orders’. This gives investors the opportunity to buy and sell ETFs at a predetermined price.

What are the disadvantages of ETFs?


Just like shares, the value of ETFs can rise and fall which means there is a degree of risk involved that could result in an investor losing some of their original capital.

So how are they different from an index tracker?


Index trackers, or tracker funds, differ from ETFs in that they are priced once a day. Because ETFs are traded on a stock exchange just like stocks, their price can fluctuate throughout the day and they are available for purchase or sale at any time during normal market hours.

How many ETFs should you have in your portfolio?


This is an interesting question and one without a straightforward answer as this depends on your investment goals, risk tolerance, diversification, and investment strategy among other things. Individuals investing in broad market ETFs will often find success with portfolios comprising fewer ETFs. Ultimately, your portfolio should align with your individual financial situation and investment philosophy. If you are in any doubt, a fully managed portfolio may be a better option for you.

FAQs

Certainly, having a single ETF in your portfolio would offer much greater diversification than a single stock. It is also easier to invest in an ETF as this requires less analysis of the company behind the stock in question.

Yes, ETFs are an easy way to enter the stock market. However, every investor should undertake some preliminary research on the ETF they are considering.

As an investor you should seek to own enough ETFs to offer full diversification along a range of sectors and geographies and few enough to monitor each fund effectively. Experts will often recommend between 3 and 10 ETFs in order to achieve this balance.

The lowest cost way to own ETFs is via InvestEngine.

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