Think of ETFs as a shipping container full of investments like shares and bonds. If you invest in an ETF, you buy a share of the entire container and own a tiny slice of every investment in it.
ETFs allow investors to buy a number of shares in a single trade. As the name suggests, you invest your money into a fund, similar to how it would work with a company like Kiwi Wealth. The difference is, rather than giving a finance company your money and getting 'units' in a fund, you buy shares in a fund via the share market.
As with most things in finance, there are a lot of acronyms, but here are some basics you should know about:
- Index: An 'index' is a categorised list of investment options, e.g. 'the largest 500 companies on the US share markets', or 'the 10 companies with the highest dividends on the NZX'. These lists are created and managed by companies like Standard and Poor's (S&P) and are often used by investment managers as a benchmark.
- Index fund: These are passive funds that aim to 'track' or mimic an index. Companies like Vanguard and Blackrock create funds like the Vanguard S&P 500 Growth ETF and the SPDR S&P 500 Growth ETF. Both track the same S&P 500 index.
- Passive: A passive strategy means the investment team isn't making active investment decisions to try to beat an index; instead they spend their time replicating an index. Because there's no human expertise involved, passive ETFs usually have lower fees. Fans of passive investing point to evidence that in the long run, it's unusual for an actively managed fund to beat the index, and they prefer the low fees.
- Active: Investment teams or individual experts try to beat an index using their knowledge of companies and the markets. They combine in-depth research, market forecasting, and experience to make decisions. You usually pay additional fees for their expertise and the frequent trading they use to attempt to beat the market. Fans of active investing believe they've picked a smart investment management company that is capable of beating the index. They also feel that when the markets drop in value, active management can limit the impacts by making smart decisions, where passive funds just track the market down.
ETFs are a relatively easy way to automatically diversify your portfolio without having to have expertise in specific sectors or markets. Rather than picking a handful of individual companies yourself (putting all your eggs in a few baskets), you can automatically spread your investment over tens, or hundreds of companies. You may minimise the joys of watching a company you've invested in really take off and deliver crazy returns, but on the flip side, if one of the hundreds of companies fails, you aren't as negatively impacted.
Which one should I choose?
Hatch lists over 500 ETFs. Some popular types of ETFs are listed below with a few examples. This isn't an exhaustive list, just a starting point for your research:
- Total share market: These ETFs aim to give you the most diversification possible by including companies across all the share markets in the world like the Total Stock Market, or one or more individual markets like Emerging markets or the US Total Stock Market
- Trends/Thematics: Allow you to spread your investment across multiple companies involved in a movement like Innovation, Robotics and AI and Biotech
- Index: About 5,000 indexes are tracking various parts of the US share markets. Some of the largest index funds are the S&P 500 ETF Trust SPDR, Core S&P 500 iShares ETF and US Total Stock Market Index Vanguard
- Sectors/industries: Allow you to invest in a lot of companies within an industry without having to hand pick each one. Examples of sector-based ETFs include Cannabis, Gold, Fintech, Aerospace Defense
- Other investment strategies: You can find ETFs that focus on everything from promoting gender diversity to getting dividends