Which stock should I invest in? I don’t have time to research all those stocks. Can we just buy all stocks for diversification? Well, the answer is yes, you can! Introducing you to the Exchange-Traded Fund (ETF). What is an ETF investment? Let’s dive in!
What is an ETF?
ETF allows investors to buy a basket of stocks (or bonds, commodities, etc) at once.
For example, with a single ETF that tracks the S&P500 index, you can have exposure to the whole top 500 companies in the US. Much simpler than buying 500 different stocks yourself, right?
ETFs are traded on an exchange just like regular stock. ETF is perfect for investors who want to diversify their portfolios. It provides an easy and affordable way for investors to have exposure to many assets in one simple, low-cost fund.
ETF can be passively or actively managed. Passively managed ETFs usually track a specific index, such as S&P500, Hang Seng Index, or Straits Times Index. As a result, the management fee (expense ratio) is also on the low side. Actively managed ETFs usually pursue a more particular investment objective, such as mirroring existing mutual funds or fund managers’ top picks. Due to the more sophisticated objectives, the expense ratio tends to be higher on actively managed ETFs.
Types of ETF
Different ETFs may track different asset classes. Some of the most common types of ETFs:
Equity ETF
This ETF tracks an index of equities. It can track large and small market caps or sectors such as tech, banking, etc. It can also track broad market indexes such as S&P500 or the world index. Investing in equity ETF is perfect for investors who want exposure to the equities market without manually researching individual stocks.
Bond/Fixed-Income ETF
Instead of holding individual bonds, you can buy bond ETF to diversify your risk across many bonds. Holding diversified bonds reduces the risk of bond default that may significantly impact your portfolio—however, note the fundamental difference between holding individual bonds and a bond fund. Bond funds are susceptible to interest rate volatility. Please know the relationship between bond yield, price, and interest rate to avoid losing your initial capital.
REIT ETF
Singapore REITs (Real Estate Investment Trust) is one of Singapore’s most popular investment choices. But investing in REIT carries its unique risk profile. You need to do deep research on the REIT portfolio, debt profile, tenants profile, and management competency just to understand the health of the REIT. What if you don’t have the time to do all those research regularly? Instead of investing in individual REITs, you can invest in REIT ETFs. Singapore REIT ETF can be an alternative for the ‘more passive’ investors who want exposure to the Singapore evergreen property market.
Commodity ETF
Commodities are asset classes that are usually more difficult to have exposure to for regular investors. Let’s suppose you want to have exposure to silver. Investors must buy and store a silver bar somewhere to keep it safe. And by the way, trust us; the silver bar is quite big 🙂 It’s just a hassle to have exposure to the commodity prices. We haven’t even talked about oil, wheat, etc.
Commodity ETFs solve this issue. By buying commodity ETF, you let the ETF manager handle the physical handling of your silver bar in return for a small fee. Please note that not all commodity ETFs hold the physical commodity behind them, as some use derivatives as the underlying assets. Regardless, it should still track the intended commodity price.
Leveraged ETF
Leveraged ETF is a double-edged sword. This tool is excellent for traders who know what they are doing but can be deadly for regular investors who do not understand what they are investing in. Leveraged ETF is simply an ETF that utilizes derivatives or debts to amplify its return. For example, a Triple QQQ (TQQQ) ETF seeks to return 3x more than QQQ ETF. SQQQ seeks to return 3x short of QQQ performance. Because of the 3x leverage, if you are on the right side of the trade, you will make 3x more money. If you are on the wrong side of the trade, you will lose 3x more money. Because of this, leveraged ETFs should only be used by sophisticated traders.
Long-term investors generally prefer to avoid this kind of ETF as the expense ratio (fee) is high and not ideal for holding for a long time.
Other ETFs
There are many more ETF types that we cannot cover here, such as currency ETFs and other specialty ETFs. In general, ETF allows investors to enjoy diversification or easy access to an asset class that is harder to manage individually.
What to look for in an ETF?
ETF investment sounds good? Yes, but investors should still know what to look for when choosing an ETF.
Expense ratio/fees
Fund managers run those ETFs, so there is a small management fee. ETFs generally have a low cost, but you still want to compare the fee among other ETFs tracking the same index. Investors need to weigh the ETF manager’s reputation and the fees they charge. Generally, the lower fee, the better, as this fee is being charged every year, thus affecting the ETF performance over a long time.
Reputation
This refers to the reputation of the fund manager who manages the ETF. What is their track record, how long have they been in the business, etc? As this is your hard-earned money, you will feel more comfortable investing it with a manager with a good track record that has been in the business for longer.
Tracking error
ETF usually tracks an index. But unfortunately, it does not perfectly track that index. The difference is called the tracking error. The less error is generally better because it is more predictable.
Asset Under Management
The size of assets under management (AUM) may not be the most critical metric to consider, but generally, we look for ETFs with a decent AUM size. A larger AUM means more liquidity. Additionally, smaller AUM may be less profitable to the ETF manager, thus a higher chance for the ETF being dissolved.
Summary
With ETF investment, investors can gain exposure to all the underlying assets in that ETF in one simple, low-cost fund. ETF allows investors to enjoy diversification with minimal effort and cost. ETF investment suits investors who prefer to be more ‘passive’ with their investing strategy.
