What is an ETF: tips for beginners
ETFs have become a popular option for investors. Let’s take a look at what they are and how they are different to other funds.
IN A FEW WORDS
ETF fundWhat is an ETFHow do Exchange Traded Fund work
7 min reading
How do Exchange-Traded Funds (ETFs) work?
Exchange-Traded Funds (ETFs) have become a very popular investment product nowadays. They are a type of passive investment, as after signing up investors don’t need to do anything except monitor the ETF to check its performance.
An ETF is considered a medium/low-risk investment, a useful tool for balancing higher-risk investments and investing long-term. Let’s look at what an ETF is, how Exchange-Traded Funds work and what benefits they offer to investors.
What are Exchange-Traded Funds (ETFs)?
Many investors are already familiar with Exchange-Traded Funds, although some people and novice investors don’t really know what these financial products are. The ETF is a fund that is listed on the stock exchange and is made up of a number of securities, usually bonds and shares, but can also include commodities and currencies.
An ETF is a diversified investment tool, and it contains many different bonds. This feature reduces the overall risk by dividing the capital into a number of bonds rather than investing the entire sum in one single asset.
Exchange-Traded Funds can replicate a particular index, for example, the London Stock Exchange’s FTSE 100. In this case, the ETF will be made up of all the securities in the FTSE 100; therefore, by purchasing it you can invest in all the shares that make up the index.
In other cases, ETFs can be built in a different way, for example by targeting a specific sector (fintech or pharmaceutical), a commodity (petrol or gold), or other types of activity. Unlike shares that have just one underlier, ETFs have various underlying assets to ensure a high level of diversification.
How do Exchange-Traded Funds (ETFs) work?
An ETF is a financial product created by a specialist company that decides the composition of the Exchange-Traded Fund and the benchmark. Following this, the ETF can be managed by the same provider or by a different company. The ETF is then listed on the stock exchange so that investors can buy fund shares.
When an investor purchases an ETF, they own part of it and each part allows them to invest in all the assets that make up the ETF. For example, although it would be impossible to buy all the shares in the FTSE100 with £5,000, this amount would nevertheless allow you to buy one or more of the ETF shares that replicate the FTSE100.
An ETF is purchased in the same way as a listed company share; therefore, you can also sell ETFs on the market to other interested investors. Those who purchase ETF funds do not also own the underlying activities, just their fund share. The fund price partially reflects the underlying asset trends; therefore, the value and return of Exchange Traded Funds can vary based on that of the underlying ones.
The cost of investing in ETFs
Investing in ETFs involves a number of costs. These are fund fees for managing and maintaining the Exchange-Traded Fund. ETF fees are shown in percentages, with an average of around 0.5%.
You must also include the intermediary fees for purchasing the ETF, with costs required by banks and brokers being either fixed or variable.
Different types of ETFs
Nowadays, there are many types of ETFs on the market, with investment options suited to any budget and financial goal. Here are the main Exchange-Traded Funds you can buy:
- Bonds ETFs: these are low-risk funds made up of government and corporate bonds with no expiry date
- Stock ETFs: these are made up of numerous listed company shares, replicating a reference index or sector
- Commodity ETFs: some ETFs have raw materials as underliers, a useful option for protecting your wallet from inflation
- Currency ETFs: these ETFs replicate a currency or a currency index, using the Forex market and national currencies as a reference
What is a UK ETF?
ETFs can follow different investment strategies. Some ETFs have a specific geographical location, for example only investing in bonds in the United Kingdom, such as the London Stock Exchange’s UK Large Cap and UK Mid Cap. Others can include assets from other countries such as Japan or the United States, or can extend to the whole of Europe, the Asia-Pacific area or have a global presence.
The benefits of investing in ETFs
Investing in ETFs offers important benefits to investors. They are simple tools to use; in fact, you can buy ETFs in the same way as you buy shares. Also, they help better diversify your investments by reducing risk, protecting your capital from the market’s volatility and from higher-risk investments.
ETFs also have low costs and fees compared to other financial products; they can be sold at any time and liquidated quickly. An ETF is also a useful option for those who have limited money to invest. They are also secure investment products. In fact, if the manager or intermediary fails, you don’t lose the money you’ve invested as the ETFs are simply transferred to other companies.
With Fineco Bank you can invest in ETFs online easily and at a competitive rate. You can also invest in ETFs automatically by choosing a Fineco regular investment plan starting from just £50. Once you have decided on your objectives you don’t have to do anything else, and you can close your investment at any time.
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