ETF Academy What is an ETF?
ETFs are the modern way to invest in a diversified manner. Individuals with small amounts of capital can benefit from features which were previously only enjoyed by large institutional investors such as pension funds. Most ETFs are index funds.
An ETF is a fund that trades on a stock exchange. The first ETF was introduced in 1993. It was a major innovation in finance, for the reasons below.
In a nutshell, the ETF is the simplest way to "buy the index" as an ETF can be acquired in a single transaction on a stock exchange. It’s an innovation that is democratising investment; arguably its full potential is yet to be appreciated.
Performance comparison of an ETF and the underlying index
Past performance is not a reliable indicator of future performance. Source: VanEck, Bloomberg. Data as of 28/10/2015 - 31/7/2021.
ETFs vs mutual funds
Explaining why ETFs have advantages over mutual funds can get complicated. Below are three main advantages:
- Costs: ETFs are far cheaper than mutual funds. As discussed in the previous module, this logically translates into higher returns over time.
- Transparency: ETF managers make a virtue of being transparent. They publish total expense ratios which show all the costs an investor has to pay. By contrast, mutual funds costs are often opaque, with little reference to trading costs or operational expenses. Additionally, with an ETF you know exactly what you’re investing in as the index’s constituents are publicly known. Mutual funds require more trust from investors. There are too many instances of mutual fund managers straying from what they said they were investing in, with bad consequences for their investors.
- Liquidity: ETFs are bought and sold on stock exchanges. You can buy and sell whenever the stock exchange is open through an online brokerage account. You also know exactly the price you’ve paid. What could be simpler? By contrast, mutual funds transactions are typically only executed at the end of the day, and the price is only set at that moment.
Investors should consider risks, i.e. risk of capital loss, before investing.
The following table summarises the differences between ETFs, mutual funds and individual stocks.
ETFs compared to other products
|ETFs||Mutual funds||Individual stocks|
|Tradable||All day||Max 1x per day||All day|
ETFs are transforming the world of investing. It lets you create a well-diversified portfolio with minimal costs. Theoretically, the world of the professional investor is in reach of the private individual. Nowadays, ETFs cover all common asset classes – from shares (stocks) through to bonds and commodities. Beyond that, there are thematic ETFs that allow investors to invest in an economic theme they believe is prospering, such as semiconductors for computing or renewable energy.