What are ETFs and should you invest in them?
According to data published by the FCA, around 41% of adults in the UK invest their hard-earned cash – and some of those adults choose ETFs as their investment of choice.
While ETFs might not be a new concept, they’re growing in popularity with an increasing number of individuals looking to expand their portfolios during tough economic times.
If you’re not sure what ETFs are or whether they’re right for you, we’ll give you everything you need to know below.
What is an ETF?
An exchange traded fund (otherwise known as an ETF) is an investment that monitors the performance of an existing market or group of markets.
The fund will have bought the assets it’s based upon or – more common in more advanced ETFs – it’ll use different investments to mimic the market’s underlying movements.
Just like traditional stocks, ETFs are bought and sold on a stock exchange. You can usually buy ETFs to track a particular index, sector or commodity. You can also use ETFs to track stocks from a particular country.
How do ETFs work?
Most ETFs are designed by fund managers to track the performance of a particular asset or asset group. For example, they might track the performance of FTSE 100 companies.
It works similarly to a stock but if you invest in an ETF, you won’t have any rights to the underlying assets in the fund.
- Is it worth investing in an ETF?
Some of the benefits of investing in an ETF fund include:
- Diversification: Rather than putting your eggs in one basket (as is the case with stocks), ETFs give you access to a range of investment options which cover various asset classes, sectors and locations. This spreads your risk – if one asset goes downhill, the others can pull it back up.
- Cost-effectiveness: ETFs have lower costs compared to investing in the assets of the fund individually.
- Efficiency and access: It’s much easier to buy and sell ETFs compared to other assets. All you need to do is trade them on the stock exchange during the market’s opening hours.
However, investing in ETFs isn’t without risk. Here are some reasons why an ETF might not be for you.
- It’s not risk-free: While it’s not as risky as other investments like crypto, ETFs can go down in value. If you do want to invest, it’s important not to invest more than you can afford to lose in a worst-case scenario.
- Lower dividend yield: Some ETFs will pay dividends, but these are usually significantly less than the dividends paid to those who have invested in the stocks themselves.
- Less control: With ETFs, you can’t select the individual assets in the fund as an expert will do the work for you. While that’s good for novice traders who are time-poor, if you’re looking to avoid a particular sector or company for ethical or political reasons, an ETF might not be for you.
ETFs can be a valuable addition to your portfolio
Before you make a trade, it’s important to understand what ETFs are and whether the benefits outweigh the potential drawbacks. If you think they do, ETFs can be a valuable addition to your portfolio.