Exchange-traded funds (ETF’s) are securities traded on stock exchanges, just like stocks. They usually try to replicate the performance indices such as the S&P 500 or the SMI index. They are usually not actively managed and therefore fairly cheap compared to other managed funds (for example mutual funds). ETF’s can be compared to a basket of stocks that replicate an index or another collection of securities.
If you were to buy an ETF of the SMI (Swiss Market Index) you are automatically invested into the 20 largest Swiss stock-listed companies (list below as of January 2020).
|3.||ROCHE HOLDING AG||17.3%|
|4.||ZURICH INSURANCE GROUP||5.6%|
|5.||COMPAGNIE FINANCIÈRE RI..||4.8%|
|9.||CREDIT SUISSE GROUP AG||3.1%|
|16.||SWISS LIFE HOLDING||1.8%|
|19.||ADECCO GROUP AG||1.0%|
|20.||THE SWATCH GROUP SA||1.0%|
That gives you an immediate diversification, without having to buy 20 individual stocks. By buying an ETF you don’t have to worry about constantly keeping track with the up and down volatility of each share.
Let’s say you buy one hundred shares of an SMI Index ETF (for example the iShares SMI ETF (CH) ISIN CH0008899764). In essence you will have bought 18.7 Nestlé shares, 18.4 Novartis shares, 17.3 Roche shares… etc. Got it?
You become a partial owner of the companies represented in the ETF and are therefore entitled to the dividends distributed by those companies.
ETFs are not free…
… but they are still the best value for your investment dollar (or franc 😊).
Total Expense Ratio
The cost of an ETF is expressed by the Total Expense Ratio (TER). TER is a measure of the total costs associated with managing and operating a fund. These costs consist primarily of management fees and other expenses such as trustee, custody, transaction and registration fees and other operating expenses. The total cost for the fund is divided by the fund’s total assets and expressed as a percentage which represents the TER.
Actively vs. Passively Managed
ETFs can be separated in two categories: actively managed and passively managed.
Actively managed ETFs, as the word suggests, has a team of humans making decisions behind it. As a consequence they are generally more expensive then their passively managed counter parts.
Passively managed ETFs track an underlying index or sector. They mirror the movements of an index by matching the weightings thereby replicating the movements of the index.
The Vanguard S&P 500 ETF (Ticker: VOO) is one of the cheapest ETFs in the market. It replicates the American S&P 500 index, is passively managed and has a TER of 0.03%.
One share (at the time of writing) costs 296 USD, every year the expenses to own the ETF will cost you 0.03% of the current price of the share. That is only 9 cents per share per year! See for yourself:
That is pretty cheap right? But that’s not all, the Vanguard S&P 500 ETF had a dividend yield of 2.1% in 2019. Assuming that the underlying 500 companies don’t all decide to cut their dividends in 2020; we can safely assume that the dividend will stay the same, which means that you get 2.1% of the price of the share paid out in cash every year as dividends.
As you can see, the dividend more than makes up for the yearly cost of the share. This is without considering the value increase of the share! Assuming the markets will remain “bullish”.
As a novice investor or somebody that is just starting to think about investing your hard-earned money for your retirement; chances are that you don’t even know where to start.
With broad index ETF you are less exposed to the individual change of one company, or one industry, and can gain some investing experience at a relatively low cost, while keeping your risk low.
I will try to put together a ETF shortlist for a future post.
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