What is ETF and how to make money on it

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

This financial instrument allows you to receive income by buying a part of an already formed portfolio instead of separate shares.

What is ETF

The abbreviation ETF comes from the English exchange-traded fund, which means "exchange-traded fund", or exchange-traded investment fund.

If you've read something about investing before, you've probably come across advice to diversify your portfolio. This means that you need to invest in the shares of several companies. If one goes bankrupt, then you will have hope for the others.

ETF is a portfolio of securities already formed by someone. By investing in it, you are not buying specific shares, but a share in this portfolio. That is, in fact, become the owner of all the shares of the fund, albeit not solely.

It is pertinent to compare investing in an ETF with making salads. You can cut food for the Olivier basin for a long time and stubbornly, or you can buy the dish ready-made. ETF is already such a ready-made "investment salad". A pleasant difference from a purchased Olivier is that the cost of an ETF is practically the same as the cost of its components.

Mikhail Korolyuk Head of the Trust Management Department of IFC Solid JSC

In its essence, an ETF is similar to a mutual investment fund (MIF), in which you can buy part of a portfolio in the same way. But in the case of a mutual fund, you acquire exactly the share and do it through the management company. ETF units are stocks and are traded on an exchange through brokerage or individual investment accounts (IIS). So, unlike mutual funds, ETFs can be bought at any time.

ETF is traded like an ordinary share, quotes from the beginning of the trading session change every second. Sometimes ETFs are paid a minor dividend.

Oleg Bogdanov Lead Analyst at QBF

Accordingly, they make money on ETFs in the same way as on ordinary shares: they buy cheaper and sell more expensive, or receive dividends. The latter usually pay out US ETFs. In other cases, you need to carefully read the fund's policy in order to understand what you can apply for.

What determines the structure of the ETF

According to Oleg Bogdanov, ETFs are often focused on a specific sector of the exchange market. For example, industry funds are aimed at the banking, technology or retail segment, while commodity funds are aimed at areas related to oil, gold, and gas.

Then there are ETFs that focus on stock indices. An index is a collection of companies whose securities are considered the most valuable by its creator. Accordingly, an index ETF is a portfolio where the shares of these companies fall. For example, the most popular of these is the SPDR S&P 500 fund, which is based on the US S&P 500 index.

You can find out the structure of the ETF at any time, in contrast to the same mutual fund, for which it is announced once a quarter.

What are the benefits of ETFs

Simplicity

If you want to build your portfolio of stocks, you will have to keep track of many securities to figure out which ones are worth dealing with. Moreover, the matter will not be limited only to the purchase, because it will be necessary to follow the rates in one way or another, to think what when to buy and what to sell.

Of course, as with any financial instrument, in the case of ETFs, it is worth learning more about securities and analyzing the portfolio structure. But they collect and balance it for you. It remains for you to use your knowledge to choose a good ETF.

Low entry threshold

In theory, you yourself could take any index and buy stocks on it. In practice, this requires a lot of money, because securities are not cheap and the price of the issue reaches several million.

But almost anyone can afford a piece of a portfolio of such stocks. For example, an FXUS share, a FinEx ETF that follows the Solactive GBS United States Large & Mid Cap Index, will cost 5,200 rubles.

Less risk

For example, if you personally buy bonds of three companies, investing in them equally, and one of them goes bankrupt, you will lose a third of your capital. In an ETF formed from bonds, there are more issuers - and a default of one of them will obviously not do the trick.

It is important not to confuse the concepts of "less risk" and "no risk", because there is always risk.

Portfolio transparency

You can see what it consists of at any time.

What are the risks of ETF

Mikhail Korolyuk notes that, by and large, the main and only danger of ETFs is exactly the same as that of any investment decision: it may turn out to be wrong within the time allotted for it. Gold, Eurobonds and shares of oil companies - everything can get cheaper.

Another disadvantage of ETFs is that they only cover the most common investment ideas. For example, you will not be able to buy ETFs of Russian computer game manufacturers, because this is an unobvious set of securities and no one forms it.

However, the available assortment is quite enough for many investors, including professionals, who do not hesitate to acquire such assets in their portfolios.

Mikhail Korolyuk

What to look for when choosing an ETF

Portfolio structure

Obviously, you want the ETF to be collected from nothing. The fund as a whole bears the same risks as the instruments that it includes.

But it is also important that its content corresponds to the period for which you are going to invest. For example, if you plan to withdraw money in three years, then it is more profitable to invest in a bond portfolio. They are more stable, so the chances of winning from such a deal are higher. If you are planning to invest for a longer time, then it makes sense to invest in stocks. Their rate can fluctuate more dramatically, but in the long run they show more profitability.

Dividends

They can be a nice addition to your income. On the other hand, if the fund invests all payments from the securities included in it in the growth of the portfolio, this may also make sense. Here you should choose what is more important to you.

Commission size

It is obvious that the provider company - the fund organizer is engaged in portfolio formation and management on a non-charitable basis and takes a commission for its mediation.

As a rule, it is not high, it is debited automatically every day. The size of the commission in the Russian Federation is on average about 1%. There are funds in the world even with zero commission.

Evgeny Marchenko Director of E. M. FINANCE

Replication method

Replication is how money is managed in ETFs. It can be physical and synthetic. In the first case, money is invested directly in stocks or any other assets, in the second - in derivative financial instruments, such as futures or options.

Among the precious metals funds, synthetic ETFs are popular, which do not invest clients in gold directly, but only in derivatives, trying to repeat the price movement. The risks of such products are much higher.

Evgeny Marchenko

Fund volume

That is, the amount that is managed by the ETF.

The larger the fund, the less profitable it is, but this profitability is more stable. The optimal size under management is $ 100-300 million.

Olga Komarovskaya Head of Litigation Practice, IP Patent Bureau

How to invest in ETF

To buy shares in a fund, you need to open a brokerage or individual investment account. This is done through a broker. How to choose it and what to look for is described in detail in the material on IIS.