Beware: Not all ETF's (exchange traded funds) are what they seem

Exchange Traded Funds (or ETF’s) have become very popular, particularly over the past 5 years. In fact, the amounts invested in ETF’s has doubled over this time. Last year (2020), Australians invested over $20 billion in ETFs.It is true that there are some advantages to investing in ETF’s. However, of course, not all ETF’s make good investments and there are some common pitfalls you must be aware of.What is an ETF?An ETF is simply a managed fund that is owned in a company structure and that company is listed on the Australian Stock Exchange. The only assets the company holds are the underlying investments. For example, for an ASX200 ETF (such as A200 or IOZ), the company would own the top 200 listed stocks proportionally according to their market capitalisation (value).You can invest in an ETF using an online share brokage account, such as Commsec.What are the advantages of ETF’sPrior to ETF’s, the only way to invest in a managed (or index) fund was directly with the investment manager e.g. Vanguard.This required you to fill out an application form each time you wanted to make a new investment. The managed fund would charge you a fee each time you invested and/or divested (this is called a buy/sell spread). And some of the lower cost ‘wholesale’ funds were only available to people if they invested a minimum of $500,000.ETF’s provide a good solution as they allow you to invest in a wholesale managed fund for the cost of a share trade (which can be as low as $10) and no paperwork is required.ETF’s and LIC’s are differentETF’s tend to utilise rules-based investment methodologies (commonly referred to as index funds). These products tend to have two common characteristics. Firstly, they are very low-cost. Investment management fees are typically below 0.40% p.a. (some as low as 0.04% p.a.) Secondly, they tend to be very well diversified. You can find a list of all ETF products here.However, Listed Investment Companies (or LIC’s) are distinctly different as they tend to employ active funds management (remember that few active funds outperform their indexes in the long run). This means these funds can be more concentrated (less diversification) and tend to charge higher investment fees.Beware that they are designed for retail investorsETF’s are mainly used by retail investors (DIY investors), but a growing number of financial advisors have started to use them. In the US, substantially more institutional investors (such as large super funds) use ETF’s, but this trend has now occurred in Australia. This creates a few notable consequences.Firstly, ETF providers will promote products that align with ‘popular’ themes such as investing in technology. Popular investments attract more investors and the more money an ETF attracts, the more fees the ETF provider generates. However, we all know that what is popular doesn’t always make a sound investment. In fact, it is proven (empirical data) that investors that chase trends tMy new book is available for pre-order now: Pre-ordering the book will help me get it into bookstores. So please do me a favour - please consider pre-ordering now - links and pre-order bonus are available here: https://prosolution.com.au/book-preorder-bonus Do you have a question for the podcast? Email us at [email protected]. If you're interested in working with our team and me, discover how we can work together here: https://prosolution.com.au/family-office-servicesIf this episode resonated with you, please leave a rating on your favourite podcast platform. Subscribe to my weekly blog: https://prosolution.com.au/stay-connected IMPORTANT: This podcast provides general information about finance, taxes, and credit. This means that the content does not consider your specific objectives, financial situation, or needs. It is crucial for you to assess whether the information is suitable for your circumstances before taking any actions based on it. If you find yourself uncertain about the relevance or your specific needs, it is advisable to seek advice from a licensed and trustworthy professional.