What is an ETF and why should you care?

What is an ETF and why should you consider ETFs as part of your retirement plan?

When you’re getting started on your ETF journey, there can be a lot of information to process which can sometimes be overwhelming. Let’s get you started.

An exchange-traded fund (ETF) is like a cross between an index managed fund and a share. ETFs are one of the world’s fastest growing categories of investment products. They’re like a managed fund, but with some differences. An ETF is an openended investment fund with access to almost every corner of the market and every major asset class and traded on the Australian Securities Exchange (ASX). In investing terms, ETFs allow you to buy a suite of shares or assets in a single ASX trade and allow you to invest in markets or assets that otherwise can be difficult or expensive to access. And because you are buying diversified exposure, if one of the shares held by the ETF performs badly, it is unlikely to have a significant effect on your overall investment.

ETFs offer the same diversification benefits as actively managed funds, but usually at a lower cost

Most ETFs are passively managed funds that aim to track the performance of a given index or asset class and provide the returns of that index or asset class – less any fees. Because there are no analysts or fund managers being paid to try and beat the index, management costs are typically lower than for actively managed funds. Traditional managed funds, on the other hand, are usually actively managed by a fund manager trying to beat the market with their investing expertise, which often means higher costs for you. Some actively managed funds may outperform ETFs in the short term, but history has shown they rarely outperform them in the long run. In a nutshell, ETFs are simple, transparent, cost effective and flexible

investment vehicles that can provide diversified exposure to a range of asset classes.

Who will help me?

Investing in ETFs is simple. As they trade on the ASX, you can buy ETFs as you would shares via an online broker, your stockbroker, or your financial adviser.

When you’re ready to buy or sell an ETF, simply use the specific fund’s ASX code. A list of the relevant ASX codes for each product can be found on the specific product pages. If you already have a portfolio and are willing to put in the time managing it, then you can use ETFs to assist in balancing risk and potential return and achieve your investment goals. You may need some advice from a finance professional before making these types of investment decisions. Try to find a fee-only financial planner – or someone who does not earn commissions on your investments.

“Often, they have heard of advisers and brokers, online platforms, and apps that can invest their spare change, but are confused about where to start,” says BetaShares associate account manager Tom Wickenden.

“It’s no surprise – investing has changed a lot in recent years, and fast.”

There are three main ways to invest: person-to-person, through online brokers, and through application brokers.

“Both the app-broking and online broking spaces are continuing to evolve with new platforms frequently emerging aiming to provide simple, low-cost access, to the benefit of all types of investors. There are plenty of options to suit different types of investors, each with its pros and cons,” says Mr Wickenden.

“The most common question I get from friends about investing is not “What?” but “How?”.

“With your savings account likely earning less interest than your weekly coffee bill and all these options now available – there really has never been a better time to start investing.”

When you have someone in place, ask them these questions: •How much risk should I be taking with my money? •How much of my portfolio should I put into ETFs? •Given the size of my portfolio, how many individual ETFs would you suggest? •Which asset classes should I use

ETFs to invest in?

?•What management fees do the ETFs you are recommending charge? •Which selection of ETFs would you advise for an optimally diversified portfolio? •Do I keep my present investments, or sell them? If I keep them, which

ETFs will complement those investments? •How can my superannuation/ income stream/pension complement my new ETF portfolio?

What do you need to know before you invest in ETFs?

There are nine things to understand including an ETF’s structure, whether the ETF is currency hedged, ideal time to buy and sell on the ASX and more. 1. Understand an ETF’s basic structure and liquidity before you start to trade 2. Know what the Net Asset

Value (NAV) is, and then use the Indicative Net Asset Value (iNAV) (if one is available) to help determine the price to trade 3. Is the ETF Currency Hedged or

Unhedged? 4. Understand bid and offer spreads 5. Know the difference between

‘market orders’ and ‘limit orders’ 6. Time when you buy/sell an ETF 7. Can ETFs help deal with market volatility? 8. What happens to my assets in the event of a product issuer’s bankruptcy? Learn more about what you need to know before you invest in ETFs.

Choosing the best ETFs

There are more than 200 ETFs available on the ASX. In choosing the funds that are right for you, it’s important to consider your financial circumstances and objectives. Are you looking to round out an existing portfolio of stocks or managed funds? Then your ETFs should complement your existing investments.

If you are just starting out, you should generally include stocks and bonds and diversify within those two broad asset classes. ETFs can provide exposure across stocks, bonds, hybrids, currencies and commodities, so can be great building blocks when constructing a portfolio from scratch.

Mix and match your holdings appropriately

Create a well-diversified portfolio that seeks to include various asset classes that are uncorrelated. This means that in periods when one part of your portfolio does not perform well, another part of the portfolio may perform better, mitigating the overall effect. Try not to invest in different ETFs that all focus on the same stocks. As a start, you could consider investing in an Australian equities ETF, an international equities ETF, and a fixed income ETF.

Pay attention to cost

Don’t pay more than you need to. Index-tracking ETFs are typically low-cost, some more so than others. If two ETFs offer similar exposure, compare their management fees when making your decision.

Your goal should always be to have a welldiversified collection of investments

The management expense ratio (MER) is an annual cost (accrued daily in the fund) that covers management and administrative fees, and operating costs. An MER of 0.45% p.a. means that your investment will cost you $4.50 for every $1000 you have invested annually.

Don’t put all your eggs in one basket

ETFs offer a convenient and easy-tomanage way of building diversification into your portfolio. The exposure across multiple investments that an ETF provides is one form of diversification. But it’s also important to ensure there is diversification between the ETFs in your portfolio – there’s little point choosing two ETFs that track similar indices. Choosing ETFs that track dissimilar indices will result in a more diversified portfolio.

Spread the load

Make sure that no single ETF makes up too large a proportion of your portfolio.

What else should you look for in an ETF?

As well as the type of exposure an ETF provides, and the costs of the fund, when looking for ETFs it’s important to consider who the ETF issuer is.

You’re going to want a reliable and experienced provider with a proven track record. Choosing an investment that meets your needs along with a client-focused provider, such as BetaShares, that is committed to education and product innovation, may be the perfect match.

Your best form of risk management is diversification and it’s not a form of risk management you explicitly pay for.

You can choose an ETF ‘theme’

Do you think companies in the global cybersecurity sector, or global technology leaders such as Amazon or Facebook, may perform well? Then consider investing in ETFs that focus on these themes. BetaShares’ Global Cybersecurity ETF (ASX code: HACK) provides exposure to the world’s leading cybersecurity companies in a single ASX trade, while the BetaShares NASDAQ 100 ETF (ASX: NDQ) is a convenient way to access the top 100 companies of the Nasdaq-100, including Apple, Amazon, Google and Facebook. Or if you are looking for more stable, steady returns from fixed income, then bond or cash funds might be where the opportunities lie for you. BetaShares provides a range of fixed income options.

What risks should you be aware of when it comes to ETFs?

The performance of an ETF is dependent on the performance of the underlying assets on which it is based. So, for example, if you choose an ETF that tracks the S&P/ ASX 200 Index, and the whole market suffers a dip, your investment will also see a decline in value. This is referred to as ‘market risk’. Importantly, ETFs are regulated unit trusts, which means that they have the same legal structure as traditional managed funds. The ETF’s assets are held for the benefit of investors, and in the unlikely event that your product issuer suffers financial difficulty will not be available to the creditors of the issuer.

Investing for, and in, retirement

Those of you investing for retirement will likely have a focus on accumulation and growth but may already be thinking about what you’ll need in retirement. It may be in your interest to evaluate whether you are happy with your super, including the mix of investments and the way they are managed. You may ask whether there is a reason to set up and SMSF or investigate any other investments you should consider in retirement. Now is the time to transition into assets with capital stability, as income is not a focus, but will eventually become important. It’s also the ideal time to get ahead and prepare your retirement plan. You should consider: • What is your superannuation stream going to look like? You can do this with the ASIC Moneysmart calculator to help or see your financial planner. • Work out your budget, including day-to-day expenses and money for holidays, renovations or other assets. • Assess whether you have enough super. Should you be topping up? • Think about the transition. Do you have enough for daily liquidity and short-term lump sums? Can you afford larger drawdowns for thing such as emergencies? • Set up a timeframe for your transition to retirement, including building your retirement portfolio that focuses on income, capital preservation, and liquidity. • Set up a timeframe for commencing the transition. Do you rip off the band-aid or dip your toe. Now is the time to decide on that process. • Consider succession and estate planning. Ideal funds for this life stage are: ASX:AAA – Australian High Interest Cash ETF ASX:INCM – Global Income Leaders ETF ASX:QPON – Australian Bank Senior Floating Rate Bond ETF ASX:HBRD – Active Australian Hybrids Fund ASX: BHYB – BetaShares Australian Major Bank Hybrids Index ETF Once you have decided to retire, it may take you a while to transition out of full-time employment. You will move from receiving regular income and, instead, start getting used to drawing down from your super fund. Remember, retirement is a process, not a single point, and your portfolio can adapt to this process. At 65, you may have assets for short-term needs and liquidity but still be looking for growth. Later, you may look to shift into income assets only. You can manage your portfolio as these needs change. You may look to stop dividend reinvestment plans, as this could be handy income. You may also consider how your income and assets affect your Age Pension eligibility, and whether you have enough income to fund medical bills and insurances. The liquid nature of ETFs gives you the flexibility you need to spend, when you want to, in the first – or any – phase of retirement. Ideal funds for this life stage are: ASX:UMAX – S&P 500 Yield Maximiser ASX:RINC – BetaShares Legg Mason Real Income Fund ASX:EINC – BetaShares Legg Mason Equity Income Fund Again, any of this information should be considered general and you should seek out a financial advisor before making any investment or decisions about money.

Key considerations

What is the fund’s investment objective? Is it a passive or actively managed strategy? If the ETF aims to track an index, what is the index methodology? For example, is it weighted by market capitalisation, fundamentally weighted, equal-weighted, or rules-based? How often is the index rebalanced? If an index is frequently rebalanced, the decision to add or remove holdings can change market exposure and potentially increase trading costs, which may have an impact on investors’ returns. What are the fund’s total assets under management? What’s the difference between the fund’s return and the index’s return over time? How volatile have the fund’s returns been over time? What risks are involved with an investment in the fund?

How much do you need to start investing in ETFs?

You can start with as little as $500. Where some other forms of investment might require a significant upfront amount, there is no minimum upfront requirement beyond what might be stipulated by your broker (typically $500). That makes ETFs a great way for you to ‘dip your toe in’ and start investing.