ETFs – index trackers – are popular investment products. And that’s not surprising: They offer the opportunity to invest widely at low cost. For example, you can invest in a basket of all the companies in the AEX, or the 500 largest companies in the US. So ETF investing can be a very nice way to build wealth. Therefore, in this article, answer: how do you invest in ETFs?
In this article, we will consider the following topics:
- What is an ETF?
- How is an ETF made?
- How do you invest in an ETF?
- How to choose the right ETF?
- What factors should you pay attention to when choosing an ETF?
- Risks of investing in ETFs
- Reading an ETF name
- How much return do you achieve with an ETF?
- How do you earn from investing in an ETF?
- What is the right ETF strategy?
- Benefits of investing in an ETF
- Disadvantages of investing in an ETF
- Conclusion
What is an ETF?
As the founder of index investing, Jack Bogle beautifully put it (yes, past tense, the best man recently went to heaven): why look for the needle in the haystack, when you can also buy the whole haystack?
And that is the essence of index investing. If you are going to invest in the stock market in individual stocks, you need to do a lot of research and work to be as sure as possible to buy the right stocks, from companies that are going to give you a nice return. This can take a lot of time, in fact: we believe that if you decide to invest in individual companies, it should also take a lot of time: doing good analysis to make the best possible choices. After all, it does involve your money. But to save yourself a lot of time, a lot of analysis, a lot of research, you can invest in an ETF. You make investing easier for yourself. And we’re going to explain to you why that is.
An ETF stands for Exchange Traded Funds. An ETF, also sometimes called a “tracker,” tracks an index. This is done by making a copy of an index. A basket is then created that mimics price rises and falls of the sector or index in question. Imagine you want to invest in all the companies in the Dutch index AEX. Then you can buy individual shares of those companies. You can also invest in an ETF that tracks the entire AEX index. Then you invest in all AEX companies, through 1 single investment.
ETF investing is very simple, you can invest money each month in an ETF that tracks the global economy. By investing in ETFs, you don’t have to spend more than 2 minutes each month building your wealth.
How is an ETF made?
An ETF must be built because it must track an existing index. This can be done in 3 ways:
Full replication
An ETF that exactly replicates an index. So suppose you invest in an ETF of the AEX, the ETF buys the same 25 stocks that make up the AEX in the appropriate proportion. This way, exactly replicating an existing index, is also called “full replication.
Optimization
You also have an “optimization” Where the ETF maker builds the ETF in such a way that it is the most optimal mix. Imagine an index consisting of 100 stocks, then the builder buys only the most important stocks, so, say, 80. Because the builder is a smarter person, he has obviously done a lot of research on which stocks are best for achieving the index’s return. Thus, this way may differ from the actual performance of the index because the ETF is not exactly the same, as is the case in Example 1.
Swap based
Finally, you have so-called “swap-based” ETFs. What happens here is that the ETF builder does not buy the stocks themselves – or a portion of them as in Example 2 – but he agrees with an investment bank that he will buy the return of an index. Both negative and positive. These are called synthetic ETFs.
How do you invest in ETFs?
You can invest in ETFs through brokers. A broker is a stockbroker and can refer to either a person or a company. Through a broker, you can buy and sell stocks and bonds on the stock market as an individual. You can invest in ETFs at DEGIRO and BUX Zero.
Read more about the difference between banks and brokers here.
How do you choose the “right” ETF?
One drawback of ETFs: there are so many now! More than 7,000. See if you can fish out the gems there. You have trackers that use certain markets (US, Europe, Asia, etc.), certain sectors (tech, healthcare, food, etc.) or certain criteria (sustainable, emerging markets, etc.). Investing in ETFs also allows you to invest in otherwise hard-to-reach products or markets, but that often involves more risk.
The final choice you make depends on your investment objective. But it is also important with ETFs to look at the additional costs, the index being tracked and the historical return.
You can select an ETF in 2 ways: see which ETF you think is the right one and invest in it. Or: think about what kind of investment you want to make, pick an index with this and then find an ETF with that.
What factors should you pay attention to when choosing an ETF?
Particularly on costs. ETF investing is so popular because you can make a nice return at the least possible risk, at a low cost. Sometimes you can still find ETFs with high fees, and the higher the fees, the less you have left for yourself. Don’t want to. What you can do to find information about an ETF is to copy the ISIN code and enter it on Morningstar.co.uk. This is where a lot of information about the ETF then appears, including costs.
It is also important to look at the size of the ETF, and by that we mean: how much money is already in this ETF? This is important because with small trackers, it may happen that for the fund house this ETF is not profitable (you always pay fund fees, these are the earnings of the creator of the ETF) and they pull the plug. Moreover, research shows that fund size has a positive relationship with returns.
Then you look at which companies are represented in the tracker (also find in the Morningstar information), what exchange the tracker is traded on, what currency you can buy it in and what the fund size is.
Risks of investing in ETFs
Well the first way is the most secure way, because an exact copy. The second way is also “safe” but here the return may differ slightly from the actual index. The 3way is riskier, but if you want to invest in some commodities, exotic stocks or hard-to-trade stocks, sometimes this is the only way.
The return you can achieve – and, of course, the risk you run – depends on how the market develops. In addition, investing in certain ETFs can put you at risk in terms of dividend leakage and currency risk. So check carefully if this is covered.
In addition, investing in ETFs has the same risks as investing in other products: the value of your investments may fall and you may lose some of your deposit. History shows that over time losses make up for themselves, but even there we know by now: that is no guarantee of future returns.
Reading an ETF name
When I search for an ETF, so many variations appear, how do you choose the right one? If you have decided that you want to invest in an ETF and you search for the ETF within DEGIRO, for example, you may find that several variants appear on your screen. They all have crazy names and abbreviations, how do you choose the right one here? Taking a popular Vanguard ETF as an example, we see the following:
- The tracker/ETF name: Vanguard FTSE All-World UCITS ETF
- Vanguard = the maker of the ETF
- FTSE All-World = name of that index being tracked. You just learned that an ETF “tracks” an index
- UCITS = abbreviation of the rules the ETF complies with. In this case, to European regulations.
Sometimes behind an ETF it says DIST, which means that this ETF pays dividends. If it says ACC that your dividend is automatically reinvested.
It is also important to pay close attention to which currency and on which exchange the ETF is traded. Ideally, you want to trade in EUR because you don’t pay currency fees in doing so.
In addition, it is also very important to pay attention to the cost of the ETF! If you have your eye on an ETF, you can usually check with the provider (the maker) to see what the fees are. Once these fall above 0.75% (give or take) then it is pricey. ETFs are known for their low cost, but there are sometimes a few among them that don’t live up to that. And you want to invest in this product precisely because it is advantageous, so pay attention to that.
How much return do you achieve with an ETF?
This depends very much on what the overall market and economy does. Long term (10, 20 years) you can expect around 8% returns from investing in an ETF that tracks the All World Index.
How do you earn from investing in an ETF?
You can make money through ETF investing in 3 ways:
- Compound interest
- Share price gain
- Dividend
You can earn from investing in ETFs in several ways. Besides (hopefully) the price gain (you buy an ETF at €100 and it is worth €120 after a while), some ETFs pay dividends. Sometimes this is distributed, and sometimes reinvested. So the total gain you can make is the same as with individual stocks: price return and dividend return. In addition, when investing in ETFs, the compound interest effect also applies: interest on interest effect. Read here what that is and how it ensures that your investments keep increasing in value.
What is the right ETF strategy?
What is the “right” strategy has everything to do with your own personal investment strategy. For many retail investors, the reason for investing in ETFs is to build long-term wealth.
ETF investing is also very popular in the FIRE movement. You invest a lot of money in an ETFs and then when you have built your desired wealth you live off the resulting returns.
Benefits of investing in an ETF
The two biggest advantages of ETF investing are:
- Easy spread application
- Low cost
The advantages of ETF’ is that they are accessible and easy investment vehicles. You can easily diversify your investments at low cost. You know exactly what index you are following and what stocks are in it, of what companies. What is one of the biggest advantages of investing in ETFs is the diversification that comes with investing in an ETF. Because there are so many shares, it cannot go bankrupt. You follow an index, and the market. If you have the time (and we mean years) then you also benefit from interest-on-interest. ETFs are also easy to buy and sell and continuously tradable. You open an online account with a broker and can invest in an ETF.
In addition, ETFs have low costs. Lower than, say, investing in funds, where an investment team and fund manager often intervene. These people don’t work for nothing (duh) and charge a percentage of your investment to cover their costs. With ETFs, you delete this intermediate item which saves significantly. For example, you can trade ETFs for free at BUX Zero and also at Degiro you have a list of ETFs you can trade for free every month. These are good benefits because the lower the cost, the more money you have left for yourself!
Drawbacks to ETF investing?
Of course, an ETF also has drawbacks. We choose to have ETFs as part of our portfolio because it is fairly steady, easy and cheap. But you will never out-perform the index. And an index sometimes includes stocks of companies that – if you run an individual fundamental analysis on them – are not necessarily the “best” companies that you have the most faith in, but are in your ETF.
For example, do you want to track the 1,600 largest companies worldwide? You can. You can also invest in an ETF that is a basket of, say, European bonds, or exclusively a sector with companies that specialize in robotics, or an ETF that has a mix of European stocks, bonds and real estate. So there is very much choice. And that choice is fine, but sometimes overwhelming.
Conclusion
How to invest in ETFs: if all goes well, you now know all about investing in ETFs. Investing is ETFs is ideal if you want to invest at low cost, widely diversified and long term. It’s mega easy, you don’t have to worry about it and you let time do its work. How you can invest in ETFs.
Well, here’s a not-so-satisfying answer: we can’t decide that for you. Decide what index you want to follow, what you are comfortable with and what risk you are willing to bear. Again: we help you to have yourself, but are not going to give ready-made investment advice. If you want to go into more depth and learn more about investing, and create your own investment strategy, then the
course Starting to Invest
is for you. Here you will learn all the basics of investing in the stock market.
Again: use your common sense! And again, we cannot stress this enough: investing is deciding in uncertainty. Investing is all about risk. And: diffusion diffusion diffusion. Time time time time. Read about the power of interest-on-interest here. This is a phenomenon that can work tremendously well when you invest in ETFs.
