I’m going to try explain the hype behind an ETF’.
Not so that you go out and buy one but so you understand why you’re constantly bombarded with information about them.
Remember, information in this post is just factual, educational information. Whether you decide to buy an ETF (or any other financial product) is a decision for you – in consult with a financial advisor or tax professional if you like.
Now, lets get into the goss!
Exchange traded funds are a (relatively) new financial product. When I say new, I don’t mean cryptocurrency new but ETFs were born in the 1990s. By the age of the stock market, they are just finishing uni.
So what are they?
I’m going to try explain the hype behind an ETF’. Not so that you go out and buy one but so you understand why you’re constantly bombarded with information about them. Remember, information in this post is just factual, educational information. Whether you decide to buy an ETF (or any other financial product) is a […]
how to buy a house in Australia
the grants, schemes and free money available to eligible home buyers With rising house prices and the general malaise of Australian media putting all blame on young Australians failing to ‘save’ or ‘negotiate’ a raise, the blame has been put squarely on zennials for being unable to (magically) come up with the $1,000 per day […]
Now that you’re back from there, ETFs were created to give you – individual, retail investor without millions of dollars – access to ‘passive, index funds’.
ETFs were simply a ‘lower cost’ way and new way to give people access to bundles of stocks without creating a mutual fund so in the early nineties, there was a shiny ‘new’ factor to them.
The first ETF was technically launched in 1989 but due to a curious misunderstanding by a Judge in Chicago, they didn’t really launch until 1993. For curiosities sake, it was the American ETF ‘S&P 500 Trust ETF’ with the ticker ‘SPDR’. Funnily enough, it’s one of the most frequently ETFs today.
As the gravy train started, ETFs took off.
Suddenly, they weren’t always passively managed (i.e. just intended to mirror an index or benchmark) – instead, there started being actively managed ETFs.
Today fund holders like Blackrock, Vanguard, Betashares make bank from ETFs.
So, you know what they are but you don’t know why they’re popular.
- Low cost – i.e. the management fee is low
- Diversified – i.e. you get a lot of stocks in one
- Cheaper (per share) than an index fund
- Easy to access – just find a broker you like!
- Can buy direct and own them in your own name (as opposed to a mutual or managed fund)
- Slightly more tax efficient than managed funds (but go DYOR on this one!)
You know I love to provide conflicting commentary, so if you’re up for it:
If that didn’t make sense, Peter is essentially saying people overlook the liquidity risk with ETFs. That is, that given they are simply a trust – a basket of stocks – if everyone sells at once, like for example, during a global financial crisis – the fund may not be able to meet the demand for people to sell out.
This is liquidity risk.
i.e. the risk that I cannot sell quickly.
Now most ETFs do attempt to mitigate this. Vanguard’s PDS outlines the fact that they keep cash on hand to ‘provide liquidity’ and they utilise a money-maker to help maintain liquidity but as Peter says, in exceptional circumstances – you may not be able to sell when you want to sell.
His second gripe is that ETFs are tax inefficient.
I find this one funny because this is counter to what everyone else says about ETFs but his reason is this he is comparing them to listed investment companies which (at least in Australia) can benefit from franking credits and fully franked dividends.
2. Everyone loves to talk tax
I’m not going to get into this part of ETFs in great detail because I honestly think this conversation is best had with a financial advisor or accountant but if you want an explanation, I like this article from Stockspot.