Intro to Investing: Exchange-Traded Funds (ETFs)

Exchange-traded funds (ETF) is a basket of stocks that trade on an exchange and can be managed by either a fund management company or actively managed by the stockbroker.

The ETFs provide a way for traders to diversify their investments and hedge against risk. The key difference between ETF and Unit Trust is that an ETF doesn't charge any management fees as there are no fund managers involved in the transactions.

Explanation: Now that we've talked about stocks and Unit Trusts, a simple way to understand ETF is to think of a Unit Trust specialising in an index.

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In most cases, people usually talk about the S&P 500, although there are many different ETFs.

First, let me backtrack and explain what an index is.

Suppose we were to look at the companies traded in our Singapore stock exchange (SGX). You'll find many different companies, some you're familiar with, like DBS, SIA, OCBC, Singtel, and many more. You'll also find companies that you may not be as familiar with as there are thousands of companies on SGX.

The top-performing companies are tracked in an index to represent the Singapore stock market from this list of companies.

In the Singapore context, it is called the Straits Times Index (STI).

Therefore, the idea of the ETF is to invest in the same top-performing companies since they represent the Singapore market. (Let me just add that I'm simplifying a lot of things here, but it should give you a slightly better idea)

Things to Note: The main idea is to invest in the top-performing companies on an index rather than try to spot or find a few good companies to invest in.

If an investor believes that the Singapore market is generally stable and will grow, investing in the STI will achieve that goal. This method, however, is not perfect as the fund manager might "lack" when a company is replaced in the index, and the fund doesn't reflect that change.

Risk Consideration: In most cases, ETFs are considered lower-risk instruments. The portfolio is relatively diversified and invests in different companies from different sectors, despite being subjected to country-specific risks.

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