ETFs and indices: S&P 500, Nasdaq and MSCI China – all you need to know about them and passive investing
Investing in ETFs has become extremely popular for young investors as it can adequately diversify your portfolio without paying the premium for purchasing individual stocks or mutual funds. Here is all you need to know about ETFs.
What is an ETF?An exchange-traded fund (ETF) is a computerized system that selects companies to track in an index. The goal of an ETF is to get as close to the tracked index as possible. ETFs are a popular product for long-term investments or so-called passive investments.
ETF vs. Mutual fundsMutual funds, unlike ETFs, are managed by people. Therefore, naturally, costs are higher, and clients can expect to pay a premium of over 1 percent per annum for the investment services provided by their mutual fund. Many investors consider the premiums for mutual funds too high and decide to not cherry-pick stocks but to buy an ETF and remain diversified. However, mutual funds offer a human aspect since there is no primary index being tracked. Instead, human beings make decisions and manage the portfolio.
What kinds of ETFs are there?Nowadays, the choices are endless. You can get an ETF that tracks an index, like the S&P 500, consisting of the 500 most prominent companies in the US. The Nasdaq only tracks the 100 most prominent companies in the US and has its own ETF, the Invesco QQQ. Companies in the Nasdaq are more extensive and are often less focused on growth because they’re more established. There is also the option to choose an ETF based on a sector, industry or product. For example, there are ETFs that only select companies that focus on renewable energy.
What to look at when buying an ETFWhen buying an ETF, it is crucial to look at the fund’s expenses, also known as the total expense ratio (TER). Zero to .25 is considered reasonable, but costs can go as low as .03, such as the iShares Core S&P 500 ETF. Low TER ratios can be very appealing to investors, as it would otherwise be impossible to maintain a portfolio with the 500 biggest companies in the US while maintaining such a low TER. In addition, it might be wise to look at the fund’s past performance. While the past result is never a guarantee for future developments, it can provide valuable insights. You can easily compare how funds have been doing during bull markets, bear markets and long periods. This makes past performance a standard metric to compare ETFs. Most importantly, you should consider at the timeframe you’re willing to invest over. Longer-term investments offer more security as you remain flexible to market fluctuations. Most ETFs are stocks, but there are also bond ETFs, so it’s essential to understand your risk tolerance with your investment timeframe.
Where do I start?Most brokers offer a wide variety of ETFs, and it can be rather tricky to decide where to allocate your assets. Still, we believe this article is a good starting point for basic knowledge about ETFs. Make sure that you research your investments constantly before committing.
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