You might have heard of stocks, bonds and maybe probably bitcoin; but have you heard of ETFs – or exchange traded funds?
ETFs are products that tracks a basket of securities, allowing you to gain access to a diversified portfolio of securities (be it stocks or bonds or commodities). They are listed and can be freely traded on an exchange and by buying shares in an ETF, you are essentially buying a portion of the fund that replicates an index. The price of the ETF changes throughout the day like any other listed security.
A simple and most common example in Singapore is the STI ETF – which tracks a basket of 30 stocks listed on the Singapore Exchange, weighted by their market capitalisation. This basket is reviewed quarterly and it consists of some of the biggest Singaporean companies such as DBS, OCBC, Singtel and Singapore Airlines.
Diversified and low cost
Building a diversified portfolio is important to prevent any company specific risk events. It gives you access to broad market ownership and allows you to partake in the success of a country, region, or sector. For example, by investing in the STI ETF, you are akin to investing in Singapore’s economy by owning a proxy of the economy – the shares of the top 30 companies in Singapore. Likewise, you can partake in the success of the US economy by owning the S&P500 ETF. If you’d prefer to invest in a sector instead, the SPDR Technology Select Sector Fund allows you to invest in the biggest tech names in the world through a single fund.
Owning ETFs is a low cost method to broad diversification, as you do not have to pay individual transaction fees to own each security in the ETF. With a single purchase, you can own all the underlying assets of the ETF!
Simple and effective
ETFs provide a dead simple way to invest and own the asset class without being bogged down by all the analysis that which individual stock will do well. The reason why you don’t need such analysis is that you believe that the market has already priced in all available information at any point in time and the market is efficient – i.e. you cannot consistent outperform the market. Studies have shown that it is impossible to always outperform the market and even Warren Buffet thinks that owning an index fund is the best long-term strategy for investing.
When you own an index fund, you’re also protected against all the downright dumb, mildly misguided or merely unlucky decisions that active fund managers are liable to make
In an upcoming post, I’ll share my strategies in building an effective ETF portfolio and also some limitations of owning ETFs.