Originally published at: https://blog.investengine.com/what-is-an-etf-a-beginners-guide-to-exchange-traded-funds/
Whether you’ve invested before or you’re a complete newcomer, you may have already heard of ETFs.
Never heard of them? Well, investment into ETFs is expected to double by 2030, so you’ll be hearing about them soon enough.
What is an ETF?
ETF stands for exchange-traded fund. Like stocks or bonds, ETFs are a type of investment, or ‘asset’, you can buy and sell in the hope of making your money grow.
However, where stocks will represent individual companies, for example, ETFs group together a bunch of different companies into one neat ‘fund’.
The easiest way to think of an ETF is like a basket. The basket might be full of bonds, stocks, or commodities (things like physical gold), but you can buy and sell it as one, straightforward asset.
If you want a bit more of an extensive breakdown of what ETFs are and how you use them, check out this video from Peter Komolafe.
When would I use an ETF?
So, when would you want to buy an ETF? The simplest answer is ‘when you want to start investing’. ETFs are a great way to get your portfolio off the ground, depending on your investment goals and risk tolerance.
Most people have neither the time or expertise to build a fully functional, profitable portfolio by picking stocks themselves. Similarly, investing heavily into individual companies can be risky.
ETFs take the heavy lifting out of portfolio construction. Diversification means not having too much of a reliance on any one business, region or industry in your investments. With ETFs, you can have a fully diversified investment portfolio by only actually buying a few different assets.
Using ETFs, anyone can be a global investor. They’re slow and steady and a far cry from a ‘get rich quick’ scheme – ETFs are for slow, methodical, smart investors.
Benefits of ETFs
Let’s take a minute to explain why ETFs are such a popular investment type.
Flexibility. There’s an ETF for everything. The ability to choose from different asset types, regions, industries, themes and more means that you can build a portfolio your way.
Accessibility. ETFs are listed on one or more stock exchanges and traded just like company shares. This means they can be traded as long as the relevant stock exchange is open. This makes them super easy to use .
Cost efficiency. ETFs are a cheaper option. The amount you pay in fees per ETF varies, so take a look at their specific info before investing, but generally these fees are low when compared to other types of investing.
Transparency. Despite ETFs being made up of a bunch of different stocks, bonds or commodities, it’s easy to see what you’re investing in. Each one will have a comprehensive list of what makes them up.
Liquidity. Put simply, liquidity is how easy it is to sell your asset when you need the cash. ETFs generally offer good liquidity – which means you can generally buy and sell them easily.
How many ETFs should I buy?
Putting together a portfolio is less complicated than it sounds. It’s up to you how many ETFs you use for your investments, but there are some general parameters you can work with.
Ultimately, most investors want a good spread across different geographies and industries – this is called diversification. The idea here is that, with your assets (investments) spread out, you’re not going to suffer too much if one area has a rough patch.
So, you spread your investing out. You can build a diversified portfolio with just a handful of ETFs – perhaps you choose an S&P 500 ETF to cover the US, an emerging markets ETF to cover those, a physical gold ETF for some stability and a European markets ETF to invest a bit closer to home.
This isn’t the right blend for everyone, but around 5 ETFs would be suitable for a large number of investors.
You can add other regions, industries or asset types onto these, but conventional wisdom dictates that you probably don’t want many more than 10 ETFs in any given portfolio.
We wrote a piece on the danger of ‘overdiversification’ – you don’t need to worry too much, just don’t go collecting ETFs like playing cards.
Why are ETFs named like that?
Yes, ETF names can look complicated at a first (and, probably a second) glance. They’re called things like Invesco S&P 500 and ARK Artificial Intelligence and Robotics.
Almost always, they’ll include the name of the company that made them – iShares, Invesco, J.P. Morgan, etc. – and a little bit of info about what’s in it.
So, if it tracks the S&P 500, this will be in the name. If it’s based on clean energy, this will usually be in the title. It’s simpler than it looks and once you know what to look out for, you can scan through lists of available ETFs with ease.
Knowing how to read ETF names in a bit more detail can be helpful when choosing between them – check out our full guide to ETF naming conventions.
Where can I build an ETF portfolio?
Want to build your own ETF-based investment portfolio? Luckily, you’re already in the right place.
InvestEngine offers fee-free DIY investing so you can build a portfolio without paying any unnecessary fees – ETF costs apply but, as we’ve discussed, these are generally small.
So, why not take a look at InvestEngine’s range of features to see how straightforward ETF investing can be.
Or, you can watch our Education Series on YouTube to give yourself all the knowledge you need to invest like a pro.
Important information
Capital at risk. The value of your portfolio with InvestEngine can go down as well as up and you may get back less than you invest. ETF costs also apply.
This communication is provided for general information only and should not be construed as advice. If in doubt you may wish to consult a professional adviser for guidance.
Tax treatment depends on personal circumstances and is subject to change, and past performance is not a reliable indicator of future returns.