ETFs, chances are you’ve seen this term many times before! ETFs (Exchange Traded Funds) are popular investment products and make diversified investing easy. In previous articles we have used the term ETFs more than once, and for good reason. We believe that investing in ETFs is a great way to minimize risk and build long-term capital. In this module we are going to explain what ETFs exactly are and what you should pay attention to if you want to invest in ETFs.
What exactly is an ETF (Exchange Traded Funds)?
An ETF stands for Exchange Traded Funds. An ETF, also known as 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 in the relevant sector or index.
By investing in ETFs, you automatically create a lot of diversification. Suppose you have a basket containing a certain proportion of mini-pieces from companies. Imagine that in that basket are stocks of shoe companies: a rain boot company, a sandal company, a sneaker company, and a high heel company. Imagine that it is raining hard, then the sandal will do less well, but the rain boot will flourish. On an average, your investments are steady, because you don’t bet on one weather condition, but on all seasons. No matter what the weather does, you minimize your risk by spreading your money out.
Where to invest in ETFs?
You can invest in ETFs through many brokers. For example via BUX Zero or Degiro. With both parties you can trade (buy and sell) in ETFs for free, but with Degiro there is a max. If you place a commission-free order via BUX Zero, you can buy an ETF several times a month without transaction costs. Degiro has a so-called core selection where you can make a free trade every month in many ETFs.
The downside of investing in an ETF is that there are so many ETFs out there. This is not only because there are so many different markets in which you can invest with an ETF, but also many different providers of ETF products. Think Vanguard, Amundi, VanEck, Blackrock and more.
Not just one AEX ETF that follows the movements of the AEX (Amsterdam Exchange), but several from different ETF providers. Often these providers, despite the fact that it concerns the same underlying asset, also have a slightly different ETF product in detail.
Building an ETF
An ETF must be built. It must track an existing index. This can be done three ways:
An ETF that exactly copies an index. So suppose you invest in an ETF of the AEX, the same 25 shares that make up the AEX are bought in the ETF in the right proportion. Therefore, the exact reconstruction of an existing index is called ‘full replication’.
You also have an ‘optimization’. The ETF maker builds up the ETF in such a way that it is the most optimal mix. Imagine that it concerns an index consisting of 100 shares, then the builder only buys the most important shares, so for example 80. Because the builder is an expert, he/she has of course done a lot of research of shares that are the best to measure the return of the stock. This may differ from the actual performance of the index, as the ETF is not exactly the same, as is the case in example 1.
Finally, you have so-called ‘swap-based’ ETFs. What happens here is that the ETF builder does not buy the stock itself – or part of it as in example 2 – but he agrees with an investment bank that he buys the return of an index. Both negative and positive. These are called synthetic ETFs.