ETFs and Index Funds – A cost-effective way to diversify

Diversifying your investment portfolio is one of the best ways to grow your money, and these days it’s not only wealthy sharemarket investors who can afford to do so.

ETFs are opening up new possibilities for individual investors in Australia – let’s find out more.

What are ETFs?

ETFs (exchange traded funds) allow individual investors to buy into a diverse spread of assets, stocks and other investment classes in an affordable way. Index funds are similar to ETFs but are limited to shares only.

Using the contributions of investors like you, the fund buys the assets and divides the returns equally. In essence, it’s like a big buyer’s club that lets you enjoy a balanced portfolio without having to invest millions.
An index fund allows you to buy a small fraction of a balanced shares portfolio which usually contains the same shares you’ll find in one of the most popular indexes on the ASX.
The value of an index fund is meant to track the value of the stocks it owns, which means that your investment will perform at the same level as the Australian Securities Exchange (ASX).
An ETF is a type of fund that is traded on the ASX – you can buy shares in one using any broker, usually a more cost effective investment than a traditional index fund, and include online share trading services.
While an index fund tracks a stock index, an ETF may include investments as diverse as government bonds, corporate debt, property, and other asset classes.

What’s the benefit?

ETFs and index funds provide a convenient alternative to placing money in a low-yield savings account.

Many investment experts believe that a stock index performs as well – or better – than an actively managed fund over time, with index funds and ETFs both having much lower brokerage fees than traditional mutual funds.

Investing wisely

Before you buy into an ETF or index fund, make sure you read the PDS (Product Disclosure Statement) and find out exactly what assets are owned by the fund – this will give you an idea of what you are investing in.

While physical ETFs are funds that own the actual assets or shares that are listed on their PDS documents, there is another type of fund called a synthetic ETF which doesn’t own the actual shares but invests in the derivatives market.

Synthetic ETFs are less secure and difficult to assess, and risk-conscious investors may prefer to avoid them in favour of the traditional physical ETF which in essence buys the whole basket of shares.