“What’s the difference between shares and ETFs? Which is right for me?”
We hear this question a lot from people who are in the early stages of learning about investing. It’s a perfectly valid question, so we put it to members of our investing team to discuss.
RYAN: Scott, shares versus ETFs, is there a big difference? And which is right for me?
SCOTT: Yeah, great question. So, a share is a proportional ownership of an individual company. So, think about you might own a share of Woolworths, or a share of CBA. You own a tiny fraction of that company. An ETF is an Exchange-Traded Fund. So, let’s take the fund bit first. The fund is basically a fund manager, or an operator, will add together a whole load of different assets, package it together in one individual fund, and let you buy that, or sell that, on the market. Now, what it gives you is a diversified, in theory, or at least a grouped purchase, of a particular asset class. The most popular ones are index based ETFs. Let’s break that down. So, you might buy an ASX 200 ETF. That’s a fund manager who says “I will basically mirror the ASX 200 and let you buy all of those companies in the same proportions, with a click of one button using one Exchange-Traded Fund.”
RYAN: And what are some of the things that you should really be looking out for when buying an ETF?
SCOTT: So, what’s really important, is ETF started off being those index funds, as I said, and they’ve become, effectively, any fund, with any mandate, any idea listed on the ASX, You can buy, ETF’s that are betting on the Australian dollar collapsing, or ETFs that are betting on the oil price tripling, or ETFs that use leverage, so in other words borrowing, to try and maximise your returns. By the way, that also potentially maximises your losses, so be careful there. So, there’s lots of different components. So, first is know what you’re buying. Not all ETFs are created equal, or have the same intent. Another thing is be careful of the funds expense ratio. So, you want to pay as little as you possibly can to get exposure to the asset class that you’re looking for. So, if you’ve got to pay a very high management ratio, management expense ratio, that fund’s got to do even better than otherwise to pay back the return you’re looking for once you’ve paid that fee. So the lowest fee possible for, normally speaking, the best most diversified ETF is the right way to go. Now in terms of who’s best for which, or which is best for who, ETF is a great way to get started in investing. If you’re not sure, or you don’t want to buy individual companies just yet, an ETF is a great way to get exposure to the market. You can buy on the ASX, an ASX 200 ETF, give you exposure to Australia. Invest in S&P 500 ETF to give you exposure to the 500 of the largest companies in the US, or even an entire world ETF, which gives you effectively all stock markets, or all developed world stock markets, with a single click. They are really, really good, generally low cost, diversified ways of getting started in investing. They’ll give you a market return. If you want to beat the market, which is why you buy individual stocks in theory, unless you have a particular objective, which is different. But if you want to beat the market, you’ve got to buy individual stocks that you expect will do that for you. So often stocks can be the second journey, or second part of people’s journey, when it comes to their investing careers, to try and maximise the returns they can achieve from their investment portfolios.
RYAN: So, focusing on the first word, Exchange-Traded Fund, is there anything different in the process of actually buying an ETF versus buying shares?
SCOTT: No, it’s exactly the same. So, the reason it is Exchange-Traded is its literally on the exchange. They are still managed funds, you got to send a cheque to the fund manager, and that’s fine. They’re great. But they’re not as easily tradable. So, you want an Exchange-Traded that gives you that flexibility, that liquidity of buying today, selling tomorrow. We hope you don’t but whenever you need to get out, it’s a very, very easy redemption process. But the actual process of buying them is exactly the same as buying on the ASX. They’re listed on CHESS, for those who are familiar with that, the record keeping system of the ASX, And they are literally, for all intents and purposes, the same as owning a proportional interest in the shares that are contained within that fund.
RYAN: So no additional forms or anything that need to be filled out? It’s just buy the units?
SCOTT: Correct. Generally, if you’re buying an international ETF there may be some US tax forms, which is way outside the remit here, but yeah very, very simple. If you want a brokerage account, you could buy an ETF as simply as you buy shares in Woollies or CSL or Commonwealth Bank.
RYAN: Excellent. Thanks, Scott.
SCOTT: Thanks, Ryan.