Monday, March 21, 2011

ETF, exchange traded whatt???

Hey there

I was walking towards a shopping centre a few days ago and I came across an ad that was encouraging people to invest in a managed fund. That ad said things like investing in this fund its good for our future and encourages us to think about our financials during retirement. That got to think, is it a good idea to invest in a managed fund? or should I instead think about investing in an ETF

Exchange Traded Funds (ETFs) what are they?
Well, they are most certainly very popular in the USA and are starting to get huge amount of recognition here in Australia.

If you are not familiar with the term ETF, well as the name suggests, they are funds that are traded in the stock exchange. ETFs gives you the power to invest in a group of companies (like funds set up by investment banks), hence diversifying your portfolio and you only need to pay the cost of brokerage. Furthermore, they are traded on the stock exchange, hence, you have the freedom to buy or sell units just like buying or selling shares from other companies.

ETFs generally try and track performances of a specified index e.g. S&P ASX 200, S&P ASX 20, S&P ASX Energy, etc. So basically, when you put your money into an ETF, the managers of the ETF, uses the pool of funds provided by all investors and invests in companies listed in a certain index. As a result, when the index moves up, so does the ETF tracking it.

For more information about ETFs, check out the Australian Stock Exchange’s website
www.asx.com.au
For the list of ETFs available in Australia, check their product listing at
http://www.asx.com.au/products/managed-funds-product-list.htm#ExchangeTradedFunds

When I talk to people from a non-financial background about stock investment or trading, they often have this idea that it is very dangerous, or it is like gambling, or people lose all of their money in it and end up killing themselves. It seems like there is this fear that is attached to putting money into stocks. They very much prefer to invest their money in something else, like, real estate because its a "physical" asset or, fixed deposits, government bonds or managed funds. However, these investment vehicles carries their own risks as well and much like investing in the stock market, if you do not know what you’re doing, you can get into a lot of trouble. That is why I think its is paramount to educate ourselves constantly



S&P ASX 200

(S&P ASX 200 from ComSec)


Looking at the S&P ASX 200 chart, it starts on June 1992 at 1666 points and ends on March 2011 with 4643 points. That is an annual compounding interest of approximately 5.94%. So if you had invested $ 1 000 in all 200 companies in the ASX 200 for 17.75 years from June 1992 to March 2011, you would have about $ 2784.93. Also remember that we are still recovering from a global financial crisis, one of the worst one we've experienced. Does that mean that there is more potential for a higher return if we tracked the index? The average cash rate for that same amount of time is about 5%, the lowest being 3% and highest 7.5%. So best case scenario is if you manage to lock in a fix deposit when the cash rate is 7.5% that would be amazing but how often does that happen?

So if I didn't make the wise decision to invest in a fixed deposit when the cash rate is high, should I then turn to investing in all S&P ASX 200 companies? To do that, I'll have to either have a lot of capital to invest in all 200 or just by buy the ETF tracking it.


We can see that the ETF that tracks the S&P ASX 200 (STW) only came into existence at the end of 2004 but it tracks index very closely.

So are ETFs the way to go if I'm looking for diversification? Should I consider investing in ETFs if I cannot tolerate much risk? Can ETFs be a good alternative to managed funds or fixed deposits?

What do you think? Let me know!

Thank you for your time, please leave comments or send me an email if you like my post, even if you hate it and think what I typed is absolutely bulls*it, let me know as well. I’m more than happy to listen to your thoughts and suggestions.

It is after all, a learning experience for us all.

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