Why are ETFs so popular?
This article looks at the rising popularity of Exchange Traded Funds (ETFs) and explores 6 reasons why they are so popular with investors in Australia and around the world.
An 8 trillion dollar global industry
The size of the global market for Exchange Traded Funds (ETFs) has more than doubled in the last 5 years, with more than 8 trillion dollars invested across thousands of funds.
In Australia alone the ETF market has doubled in just the last 2 years, with almost 140 billion invested across more than 200 funds.
A growing number of investors are turning to ETFs to build their investment portfolios rather than buying shares in individual companies.
An ETF is a basket of investments (like shares or bonds) which can be bought or sold on a stock exchange. It’s like holding a slice of lots of different companies, packaged together in a single fund.
An ETF is a collection of investments like stocks, bonds, and commodities, or even a combination of these assets.
ETFs typically track an underlying index, such as the S&P 500 (the 500 biggest companies in the US), and are traded on stock exchanges just like individual stocks.
The simplest way to think about an ETF is that it’s like a bundle. Instead of the hassle of buying each individual stock, you can quickly buy a bundle of them in just one ETF.
For example, by buying one share of an ETF that tracks the S&P 500 you can invest in the performance of these 500 companies without buying each stock individually.
ETFs have been around since the 1990s but have grown rapidly in popularity over the past few years in particular.
We’ve already started touching on some of the benefits of ETFs so I’ll pause now. In this article we’re going to look at 6 main reasons why ETFs are so popular with investors:
Diversification
Transparency
Simplicity
Cost
Flexibility
Variety
1. Diversification
Arguably the biggest benefit of ETFs is the diversification they can offer.
Managing risk is essential with any investment, and increasing diversification can be a great way to do it.
ETFs can hold hundreds or even thousands of different assets (stocks, bonds, commodities etc) within them. This can drastically reduce the risk of having “all your eggs in one basket”. For example, if one of the companies performs poorly then you have a whole bunch of others to cushion the blow.
Different ETFs can offer different types of diversification, such as:
Diversification by asset class - stocks, bonds, commodities etc.
Diversification by geography - different regions or countries from around the world
Diversification by industry sector - different types of companies, offering a range of different products and services
Check out my post on Diversification for a closer look at the different ways to diversify a portfolio.
2. Transparency
The problem with other forms of investing, like mutual funds and other funds managed by investment firms, is that you don’t really know what they’re investing in at any one time.
ETFs are much more transparent.
They tend to be very straightforward in what they aim to achieve (some track a broad index like an entire country; others may track a particular sector) and also in which companies (or other assets) they hold. Most ETF providers even update this information daily on their website.
3. Simplicity
Investing can feel very confusing, complicated and at times overwhelming.
For many, the idea of researching company performance and trying to decide when to buy and sell individual stocks is completely unrealistic and not particularly appealing.
The beauty of ETFs is that they offer investors a much simpler option - a diversified portfolio in a single trade.
ETFs can be great for long-term investors who simply want to ‘buy and hold’ their investments and put as little time and effort into it as possible.
Platforms such as Pearler can help take this one step further by automating their recurring investments. Pick a handful of ETFs, set up the auto-invest feature and a regular amount will be deposited from your bank account and invested into your selected ETFs at regular (e.g. monthly) intervals.
4. Cost
What really sets ETFs apart from more traditional investments is how cost effective they are.
There are two main costs to be aware of:
Expense ratio. This is the management fee charged by the ETF provider (like Vanguard or iShares). It varies by ETF, with broader market-wide ETFs typically much lower than sector- or theme-specific ETFs.
Expense ratios of ETFs can be as low as 0.03%, which is significantly lower than the amount charged by traditional mutual funds or other managed services.
Brokerage fee. This is the amount charged each time you invest money into an ETF. This can be as low as $3 per transaction.
Brokerage fees are often similar for individual shares vs. ETFs. The benefit though is that with an ETF you are getting hundreds or even thousands of companies all bundled together. Achieving the same level of diversification by investing in individual shares would cost hundreds or thousands of dollars in brokerage fees.
5. Flexibility
The ‘T’ in ETF stands for Traded, which means that ETFs can be traded on stock exchanges throughout the day, just like other shares. As investors, we can see the price go up and down throughout the day, so that when we do buy or sell we can see pretty much the exact price that we’re going to get.
Other funds aren’t traded in the same way. With a mutual fund for example, the buy or sell order is placed but the price you get is determined at the end of the trading day. Much less transparent and much less flexible.
6. Variety
The rising popularity of ETFs has created a huge increase in the variety available to investors.
Want to invest in companies leading the way with cyber security globally? There’s an ETF for that.
Want to invest in companies involved in robotics, AI and automation? There’s an ETF for that.
Want to invest only in companies that meet strict ethical and sustainable standards? There’s an ETF (or actually multiple ETFs!) for that.
However some may argue that targeted, thematic ETFs are actually very concentrated and don’t offer the diversification benefits that ETFs are known for. This is why it’s so important to know what you’re investing in and do your own research.
Summary
ETFs can help make investing much more accessible and affordable to everyday investors. They offer a range of benefits that set them apart from other, more traditional, forms of investing.
But it’s important to know what you’re investing in.
Not all ETFs are made equal. Although some are incredibly diverse and low cost, others can be incredibly concentrated and come with much higher fees.
