• ETFs or exchange-traded funds are a useful tool to diversify your investments.
• ETFs are essentially a basket of different investments bundled together and traded on the stock market.
• By trading ETFs, people can gain exposure to hundreds of thousands of different companies in a single transaction.
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The share market can be a volatile and frankly frightening place, especially at this particular juncture.

However, outside of Australia’s prohibitively expensive property market, it also remains one of the most common ways to grow and protect your wealth.

As markets went into a spin this year, countless Australians dove in, attracted by heavily discounted stock prices. While some investors prefer to pick individual companies to invest in, others are simply looking for an easy way to get into the market and limit their risk.

The good news is there is a commonly used tool that can take the stress – not to mention work – out of investing.

What is an ETF?

An ETF, or exchange-traded fund, is essentially a basket of different investment investments bundled together and traded on the stock market.

Through buying shares in one, you can effectively invest your hard-earned dollars across a whole range of different companies in a single transaction. In many cases, you’re buying a slice of hundreds or even thousands of different investments in a single go.

What are the different types of ETFs available?

If there’s an investment class, there’s probably an ETF for it.

There are of course countless ones that track every kind of equity market from the entire Nasdaq to Australian small-cap companies.

But they go far beyond that in classification. Investors can buy ETFs to invest in everything from gold, bonds, commodities, real estate, high-growth and high-yield stocks. When it comes to stocks, investors can cut and recut the market in terms of emerging markets, specific sectors, or even large swathes of different regions, such as Asia.

As of last month, Australians can even invest in the video game industry on the ASX.

What are the advantages of investing in ETFs?

ETFs were last year worth more than $US4 trillion ($5.6 trillion) globally and owe their popularity to a whole range of factors.

For one, ETFs remain one of the easiest ways to diversify a portfolio, spreading your money widely to minimise day-to-day volatility and risk.

For another, they enable investors to pick and choose broad sectors rather than individual stocks or commodities for example. While you may fancy the healthcare sector may only grow going forward, it’s far more tricky to pick and choose the specific companies that might lead that charge.

Therein lies two of the key reasons many people turn to ETFs: ease and speed of investing. Individual companies may require many hours of research to understand them, their risks and opportunities properly, and even then you’ll likely still need to keep abreast of any developments to stay current. Conversely, you could buy a slice of the 500 largest US companies with a few keystrokes.

They can be instantly bought and sold while the exchange they are listed on is in session.

Finally, ETFs tend to charge relatively low fees, which over the long-term translates to greater returns for investors.

What are the disadvantages of ETFs?

Of course, each investment comes with its drawbacks. While diversified ETFs are lauded as ‘safer’ investments, they can also lull investors into a false sense of security.

If you were to invest all of your money into the Australian share market and nowhere else, you’d still be at risk of losing money during a stock crash. In this sense, many find greater diversification by spreading their money across different ETFs covering different asset classes and markets.

Australians particularly should be aware of currency risk as well. By purchasing an ETF that tracks in US dollars, for example, gains or losses can be multiplied as the currency exchange rate fluctuates. For example, if the Australian dollar was to strengthen before you sell, your returns will be diminished when US profits are realised and exchanged for the local currency once more.

Similarly, a leveraged ETF carries greater risk and can produce outsized returns or losses.

Is ETF investing a good idea?

Each investor must make a choice based on their individual circumstances. However, they can prove a great addition to an investment portfolio when used correctly.

There’s an argument some make that by buying so many different companies means you’ll inevitably buy good companies along with some bad ones. While that may be the case, countless studies show that active investors, or stock pickers, almost inevitably perform worse than broader markets. Long term passive investors conversely can utilise ETFs to enjoy the benefits of spreading their money far and wide.

Whether they’re right for you is a decision only you can make.

Disclaimer: This article contains general information only and is not intended to be used as personal advice.

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