What are ETFs?

If you have already familiarized yourself with our blog, you will have easily noticed that we are big fans of ETFs. And yes, we are indeed very fond of this passive, broadly diversified and super low-cost investment instrument. We are convinced that ETFs offer almost perfect investment opportunities, especially for every rational private investor and every self-determined investor. That’s why we have created an easy-to-understand ETF infographic for you, which briefly and concisely informs you about the most important features of ETFs, their advantages and disadvantages as well as some historical facts.

What are ETFs? In a nutshell

An exchange-traded fund (ETF) is an investment fund that is traded on a stock exchange, like a share. ETFs are similar to investment funds with the difference that ETF shares can be bought and sold throughout the trading day. Mutual funds are only traded at the close of the trading day. ETFs offer the best features of two popular investments: they have the diversification benefits of mutual funds while mimicking the simplicity of trading stocks. Like any financial product, ETFs are not a one-size-fits-all solution. Judge them on their own merits, including management costs and commission fees (if any), how easily you can buy or sell them, and their investment quality.

ETF = exchange-traded fund = exchange-traded fund

An exchange-traded fund – better known by the acronym “ETF” – is a fund that can be traded like a share on a stock exchange (hence the name). ETFs allow you to buy and sell a basket of assets without having to buy all the components individually. An ETF works as follows: The fund provider owns the underlying assets, designs a fund that tracks their performance, and then sells shares in that fund to investors. Shareholders own a portion of an ETF, but they do not own the underlying assets in the fund. Nevertheless, investors in an ETF that tracks an equity index receive lump-sum dividend payments or reinvestments for the stocks that make up the index. While ETFs are designed to track the value of an underlying asset or index – be it a commodity like gold or a basket of stocks like the Swiss Market Index – they are traded at market-determined prices that usually deviate from that asset. In addition, the longer-term returns of an ETF will differ from those of the underlying asset due to factors such as costs.

How ETFs work – explained in 3 steps

1. An ETF provider looks at the universe of assets, including stocks, bonds, commodities or currencies, and creates a basket with a unique ticker.
2. Investors can buy a share in this basket, just like buying shares in a company.
3. Buyers and sellers trade the ETF throughout the day on an exchange, similar to a share.

Difference between ETFs vs. investment funds vs. shares

In general, ETFs have lower fees than investment funds – and this is a large part of their appeal. While the average CH equity fund charges 1.42% in annual management costs – the so-called expense ratio – the fees for the average equity ETF are 0.53%. Within an investment fund (especially actively managed funds) there is usually more turnover than with an ETF, and such buying and selling can lead to capital gains. Similarly, when investors want to sell an investment fund, the manager must raise cash by selling securities, which can also result in capital gains. In both cases, investors have to pay these taxes. ETFs are becoming increasingly popular, but the number of mutual funds available is still higher. The two products also have different management structures (typically active for mutual funds, passive for ETFs, although actively managed ETFs also exist). Like stocks, ETFs can be traded on exchanges and have unique ticker symbols that allow you to track their price activity. There’s SPY for one of the ETFs that tracks the S&P 500, and fun symbols like CYBER for a cybersecurity fund and FONE for an ETF that focuses on smartphones. However, that’s where the similarities end, because ETFs represent a basket of assets, whereas a stock represents just one company.

4 types of ETFs: Equity ETFs dominate the market

While ETFs trade like stocks, under the hood they’re more like mutual funds and index funds, which can differ greatly in terms of their underlying assets and investment objectives. Below are some common types of ETFs – but note that these categories are not mutually exclusive. For example, an equity ETF can also be index-based and vice versa. These ETFs are not categorized by the type of management (passive or active), but by the type of investments held in the ETF.

Shares ETFs

These include equities and are usually intended for long-term growth. Although they tend to be less risky than individual stocks, they are slightly riskier than some of the others listed here, such as bond ETFs.

Commodity ETFs

Commodities are raw materials that can be bought or sold, such as gold, coffee and crude oil. Commodity ETFs allow you to bundle these securities into a single investment. With commodity ETFs, it’s particularly important to know what’s in them – do you have an interest in the physical holdings of the commodity in the fund or do you own shares in companies that produce, transport and store these goods? Does the ETF contain futures contracts? Is the commodity considered a “collectible” in the eyes of the IRS? These factors can have serious tax implications and different levels of risk.

Bond ETFs

Unlike individual bonds, bond ETFs do not have a maturity date, so the most common use for them is to generate regular cash payments to the investor. These payments come from the interest generated by the individual bonds within the fund. Bond ETFs can be an excellent, lower-risk complement to equity ETFs.

Sector ETFs

The CH equity market is divided into 11 sectors, and each consists of companies operating within that sector. Sector ETFs offer a way to invest in specific companies within these sectors, such as the healthcare, financial or industrial sectors. These can be particularly useful for investors who track economic cycles, as some sectors tend to outperform during periods of expansion, while others tend to outperform during periods of contraction. These ETFs are often associated with higher risk than broad market ETFs.

Advantages of ETFs

Diversification

While it’s easy to think of diversification in terms of broad market verticals – stocks, bonds or a particular commodity, for example – ETFs also allow investors to diversify across horizontals, such as industries. It would take a lot of money and effort to buy all the components of a particular basket, but with the click of a button, an ETF delivers these benefits to your portfolio.

Transparency

Anyone with Internet access can search for price activity for a particular ETF on an exchange. In addition, the holdings of a fund are disclosed to the public on a daily basis, whereas mutual funds do this on a monthly or quarterly basis.

Low fees

Anyone with internet access can search for price activity for a particular ETF on an exchange. In addition, the holdings of a fund are disclosed to the public on a daily basis, whereas this is done monthly or quarterly for investment funds. https://www.youtube.com/watch?v=wCTCXoZNsHE