Question
Is it a good idea to invest in ETFs and how do you pick them?Answer
Exchange Traded Funds (ETFs) are a type of investment fund traded on the stockmarket that usually aim to track an index.
When deciding whether to invest in ETFs your first question should be ‘is a tracker the best option?’ If yes, you’ll then need to decide if an ETF is a better choice than alternatives such as a unit trust.
Rather than cover the pros and cons of trackers in full detail here, I’ll suggest you take a look at our trackers page. But in summary, trackers tend to work well in some markets and less well in others.
If you want to invest in a tracker then is an ETF a good idea?
The big advantage of ETFs over unit trusts is that they cover a significantly wider range of indices. Whereas unit trust trackers only offer exposure to a few major stockmarkets, ETFs provide access to many more regional and specialist markets, as well as other assets such as gilts, bonds, commodities and property. You could feasibly build a diverse portfolio of trackers using ETFs, whereas you’d really struggle with unit trusts.
ETFs also have a reputation for being cheap. However, while this is usually true of those tracking major markets, it’s not uncommon for more specialist ETFs to have total annual charges (i.e. total expense ratios) of around 0.75% - lower than actively managed funds, but not by that much once you strip out sales commissions on the latter.
You’ll need to pay stockbroker dealing charges when buying and selling ETFs. While this is only around £10 via online brokers, it does make monthly saving a non-starter for most. Unlike shares and unit trusts, ETFs are exempt from stamp duty.
If you’re a particularly active trader then you’ll appreciate that ETFs offer real-time pricing, i.e. you can sell at the prevailing market price any time during trading day. By comparison unit trusts tend to be priced just once a day, although this is hardly a big issue when investing longer term.
There’s no right or wrong when comparing ETFs and unit trust trackers, your decision will likely rest on availability for the desired index and cost.
Start by deciding on the area or asset you’d like to invest in, e.g. the UK stockmarket, bonds or gold. You can then look at the various ETFs/unit trusts available and compare the index tracked and costs, as well as how successfully the fund has mirrored the index.
Remember that indices can vary quite markedly, so make sure you know what you’re getting. For example, is the index dominated by certain companies and/or sectors? If you’re not careful you could end up taking a bigger bet than you realise.
While most ETFs are pretty good at accurately tracking an index, there are exceptions. The offenders are usually ETFs that track commodities where it’s not practical for the fund to actually own the asset, e.g. oil and corn. The fund will likely buy ‘futures’ contracts each month to try and track the commodity price, but may well underperform due to additional costs built into the price of each month’s futures (called ‘contango’) – read more about this on our commodities page.
Overall I think ETFs are a great innovation and worthwhile for many investors. However, they’re only as good as the index tracked, so choose very carefully and don’t always assume they’re a better choice than actively managed funds.
A good source for ETF and unit trust performance figures is Trustnet.
ETF providers include: iShares, ETF Securities, Lyxor and db x-trackers.
Is it a good idea to invest in ETFs and how do you pick them?Answer
Exchange Traded Funds (ETFs) are a type of investment fund traded on the stockmarket that usually aim to track an index.
When deciding whether to invest in ETFs your first question should be ‘is a tracker the best option?’ If yes, you’ll then need to decide if an ETF is a better choice than alternatives such as a unit trust.
Rather than cover the pros and cons of trackers in full detail here, I’ll suggest you take a look at our trackers page. But in summary, trackers tend to work well in some markets and less well in others.
If you want to invest in a tracker then is an ETF a good idea?
The big advantage of ETFs over unit trusts is that they cover a significantly wider range of indices. Whereas unit trust trackers only offer exposure to a few major stockmarkets, ETFs provide access to many more regional and specialist markets, as well as other assets such as gilts, bonds, commodities and property. You could feasibly build a diverse portfolio of trackers using ETFs, whereas you’d really struggle with unit trusts.
ETFs also have a reputation for being cheap. However, while this is usually true of those tracking major markets, it’s not uncommon for more specialist ETFs to have total annual charges (i.e. total expense ratios) of around 0.75% - lower than actively managed funds, but not by that much once you strip out sales commissions on the latter.
You’ll need to pay stockbroker dealing charges when buying and selling ETFs. While this is only around £10 via online brokers, it does make monthly saving a non-starter for most. Unlike shares and unit trusts, ETFs are exempt from stamp duty.
If you’re a particularly active trader then you’ll appreciate that ETFs offer real-time pricing, i.e. you can sell at the prevailing market price any time during trading day. By comparison unit trusts tend to be priced just once a day, although this is hardly a big issue when investing longer term.
There’s no right or wrong when comparing ETFs and unit trust trackers, your decision will likely rest on availability for the desired index and cost.
Start by deciding on the area or asset you’d like to invest in, e.g. the UK stockmarket, bonds or gold. You can then look at the various ETFs/unit trusts available and compare the index tracked and costs, as well as how successfully the fund has mirrored the index.
Remember that indices can vary quite markedly, so make sure you know what you’re getting. For example, is the index dominated by certain companies and/or sectors? If you’re not careful you could end up taking a bigger bet than you realise.
While most ETFs are pretty good at accurately tracking an index, there are exceptions. The offenders are usually ETFs that track commodities where it’s not practical for the fund to actually own the asset, e.g. oil and corn. The fund will likely buy ‘futures’ contracts each month to try and track the commodity price, but may well underperform due to additional costs built into the price of each month’s futures (called ‘contango’) – read more about this on our commodities page.
Overall I think ETFs are a great innovation and worthwhile for many investors. However, they’re only as good as the index tracked, so choose very carefully and don’t always assume they’re a better choice than actively managed funds.
A good source for ETF and unit trust performance figures is Trustnet.
ETF providers include: iShares, ETF Securities, Lyxor and db x-trackers.
Read this Q and A at http://www.candidmoney.com/questions/question114.aspx
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