What are ETFs and why they should matter to you?

If you're new to investing, you've probably heard the term "ETF" thrown around. But what exactly are ETFs, and why should you care about them? Let's break it down in simple terms.

(Note - if at any point in time you don’t understand a term in the article, you can go to the Personal Finance Glossary  where I try to put all the key terms to know about when it comes to personal finance)

What is an ETF?

ETF stands for Exchange-Traded Fund. It's a type of investment that works like a basket of different securities (such as stocks or bonds) all bundled together. When you buy an ETF, you're essentially buying a small piece of this basket.

How do ETFs work?

1. Diversification: ETFs typically hold many different securities, which helps spread out your risk. For example if you buy the ETF called : “Vanguard FTSE All-World UCITS ETF (USD) Accumulating” you are actually buying a small piece of a little more than 3600 companies around the world.
2. Traded like stocks: You can buy and sell ETFs throughout the trading day, just like individual stocks. This is great because it means the ETFs are relatively liquid.
3. Lower costs: ETFs often have lower fees compared to actively managed mutual funds. To give you some ideas, a cheap ETF would have a TER (Total Expense Ratio) of 0.2% while more exotic/complex ETFs could have TER around 1%.
4. Transparency: Most ETFs disclose their holdings daily, so you know what you're investing in. Note that in Europe, traded securities like ETF need to have a Key Information Document (KID) that is standardized, allowing investors to compare different securities. You should always have a look at the KID of what you are about to buy before buying it.

Why should ETFs matter to you?

1. Easy way to diversify: Instead of buying individual stocks, one ETF can give you exposure to hundreds of companies.
2. Beginner-friendly: ETFs can be less intimidating than picking individual stocks, making them great for new investors.
3. Cost-effective: With typically lower fees, ETFs can help you keep more of your investment returns. ust like interests, cost compound so you should thrive to invest in cheap (in terms of management costs) and performing assets.
4. Flexibility: You can find ETFs for almost any investment strategy or market sector you're interested in. For example you want to invest in Pet Care? Well you have an ETF for this. You’d like to focus on renewable energy companies - you have an ETF for that too ! You get the idea 😉
5. Tax efficiency: Many ETFs are structured to minimize taxable events, which can be beneficial for your overall returns. For example, accumulating ETFs do no give you dividends as they reinvest automatically in the ETF - which avoid a taxable event for you. The opposite of an accumulating ETF is a distributing ETF.

Types of ETFs

There are many types of ETFs to choose from, including:

• Stock ETFs: Track a specific stock market index or sector
• Bond ETFs: Invest in various types of bonds
• Commodity ETFs: Track the price of commodities like gold or oil
• International ETFs: Invest in foreign markets
• Thematic ETFs: Focus on specific trends or themes, like technology or sustainability

Getting started with ETFs

1. Determine your goals: Are you saving for retirement, a house, or just want to grow your wealth?
2. Assess your risk tolerance: How much risk are you comfortable with? As rule of thumb, the more risk you are willing to take, the more equity based ETF within exotic markets you are going to invest in. The less risky you are, the more Bond ETFs you are going to invest in.
3. Research: Look into different ETFs that align with your goals and risk tolerance. I really like to use the website https://www.justetf.com/en/ for my own research. And you can read more about this in my How to pick the right ETF for you? article.‍
4. Start small: You don't need a lot of money to begin investing in ETFs. Just get into the habit of investing in it, 1€ at a time. Login once a month on your favorite broker (I use https://www.degiro.ie/ but many others are available)‍
5. Monitor and adjust: Keep an eye on your investments and rebalance as needed.

By understanding and utilizing ETFs, you can take a significant step towards building a diversified investment portfolio and working towards your financial goals.

If you are ready to invest, feel free to read my other article How to pick the right ETF for you? to understand what to look at when you are picking an ETF.

Remember, while ETFs can be a great investment tool, it's always wise to do your own research and consider consulting with a financial advisor before making investment decisions.

Feel free to book a session with me to review your current situation and assess what a good ETF for you could be.

Happy investing!

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