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Why invest in an ETF?
Toni Case
It's easy to ignore investments with mysterious acronyms such as ETFs. But before you leap off the page onto a topic more friendly and familiar, stop right there. ETFs might be just the investment that has been missing in your share portfolio.
 ETFs are short for exchanged traded funds. Investors in the United States are so wrapped in them that you can buy ETFs on just about anything. Want an investment that tracks the US technology index, mirrors the performance of the Taiwanese or Singapore sharemarket, or tracks the fortune of the oil and gas sector? There will be an ETF that will do just that. Today there are over 300 ETFs in the US to choose from.
Australian investors aren't so spoiled for choice. That doesn't prevent us, however, from buying an ETF that trades on the Nasdaq or American Stock Exchange. Check out our share trading comparison table to find out the brokers that offer international share trading.
Put simply, an ETF is as an investment portfolio that trades on the sharemarket. They're kind of like managed funds but they trade like shares - which means you buy and sell them over the ASX just like your Telstra shares.
An ETF might track the S&P/ASX 200 index, which means that the manager of the ETF will purchase all stocks contained in the index and weight them according to each company's market capitalisation. Any capital gains or losses, dividends and franking credits are passed onto you.
Because ETFs simply track an index, sector or geographic region such as the broader Australian sharemarket (S&P/ASX 200 index), they have a couple of advantages over the typical managed fund. First up, the performance of an ETF won't suffer due to a throbbing headache or a fight with the spouse - unlike managed funds, which are captained by fund managers who can suffer from human error and bad judgement. A fund manager can have a rough year. They can get their stock selection wrong and perform way below the market and their peers. If you buy an ETF, you can be fairly confident that your returns will sparkle as the market shines.
This makes choosing an ETF easier as well. Your decision to buy or sell an ETF will be, to a large extent, based on your outlook for the underlying market or sector on which the ETF is based. For example, you think the Japanese market will continue to move higher over the coming year - then you could go out and purchase an ETF providing broad exposure to Japanese stocks (of course, such ETFs aren't offered in Australia).
When choosing a managed fund you have to take into consideration the skill and experience of the fund manager running the fund, the size of the fund and the investment style adopted. Not so with ETFs.
The big downside of ETFs is that - since they track the performance of an index - when the index performs badly, so will your ETF. So during sluggish or downward trending markets, buckle up and hang on for the ride because it's guaranteed to be bumpy. Fund managers, on the other hand, can pull some swift moves and save a fund's returns from souring during bearish times.
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