ETFs simply explained: What is an ETF and how does it work?

ETFs simply explained: What is an ETF and how does it work?

ETFs simply explained: What is an ETF and how does it work?

ETFs (Exchange Traded Funds) are investment funds that are traded on a stock exchange and offer a cost-effective way to invest in a diversified manner in different asset classes. They are becoming increasingly popular among investors as they represent a simple and transparent way of investing. In this article we will explain the term “ETF” in more detail and provide an overview of how they work.

What is an ETF?

An ETF is a mutual fund that trades like a stock on a stock exchange. It represents a basket of different securities, such as stocks, bonds, commodities or other assets. By purchasing an ETF, the investor indirectly acquires shares in this basket of securities. The value of an ETF is determined by the performance of the underlying securities.

Unlike traditional mutual funds, whose value is calculated once a day based on net asset value (NAV), the price of an ETF changes continuously throughout the trading day because it is traded on the stock exchange. This allows investors to buy or sell ETFs at any point during trading hours.

How does an ETF work?

An ETF is launched by a fund company that puts together a basket of securities and chooses an index as a reference. This index can be, for example, a stock index such as the DAX or S&P 500. The fund company buys the securities that track the index and then creates shares of the ETF that can be traded on the stock exchange.

The performance of the ETF is determined by the performance of the underlying index. The goal of an ETF is to replicate the performance of the index as closely as possible. The fund company periodically adjusts the basket of securities to ensure that it continues to represent the index.

ETFs offer investors broad diversification because they invest in a variety of securities. This reduces risk compared to buying individual stocks or bonds directly. In addition, ETFs are often more cost-effective than traditional investment funds because they are passively managed and do not require active fund management.

Advantages of ETFs

ETFs offer a number of benefits for investors. Here are some of the most important ones:

1. Diversification

ETFs allow investors to invest in a large number of securities, which diversifies risk. This reduces the risk of individual stocks or bonds and spreads the overall risk of the portfolio.

2. Liquidity

Because ETFs are traded on the stock exchange, investors can buy or sell their shares at any point during the trading day. This offers high liquidity, unlike traditional mutual funds that only trade once a day.

3. Easy to use

ETFs can be bought and sold directly through a broker, just like individual stocks. This makes trading ETFs easy and convenient.

4. Transparency

ETFs are transparent investment products because they regularly publish reports about the underlying index and the value of the ETF. Investors have a clear overview of their investment.

5. Cost effectiveness

ETFs often have lower costs compared to traditional mutual funds. Because they are passively managed, there are no high management fees for active fund management.

How to invest in ETFs?

To invest in ETFs, you need a securities account with a broker. There you can select and buy ETFs. There are a variety of ETFs that cover different asset classes and markets. Investors should consider their investment objectives and risk tolerance to select the appropriate ETF.

When purchasing ETFs, there are usually special costs, such as transaction costs and ongoing management fees. Before purchasing, investors should consider these costs and select the appropriate ETF.

It is also important to evaluate the ETF's performance, the chosen index and the investment strategy to ensure that the ETF fits one's investment goals. Investors can access historical data, fund reports and analyst ratings.

FAQs about ETFs

What is the difference between actively and passively managed ETFs?

Actively managed ETFs are controlled by fund managers who actively select the securities in the ETF based on market situations and adjust the allocation. Passively managed ETFs, on the other hand, attempt to replicate the performance of a specific index as closely as possible and are not actively managed.

What returns can you expect from ETFs?

The return of ETFs depends on the performance of the underlying index. There is no guarantee of a specific return as performance depends on market factors and other influences. The past also does not allow any conclusions to be drawn about future returns.

How often should you check ETFs?

The frequency of reviewing ETFs depends on individual investment goals. Some investors review their portfolios regularly and adjust their allocation accordingly, while others have a long-term investment horizon and trade less frequently. It is recommended that portfolios be reviewed regularly and adjusted if necessary.

Conclusion

ETFs offer investors a cost-effective way to invest in a diversified manner across different asset classes. They are easy to use, transparent and offer a wide range of options for investors with different investment goals. However, before investing in ETFs, you should carefully consider your investment objectives, risk tolerance and the characteristics of the ETF. ETFs can be a valuable addition for investors looking for a diversified and low-cost investment strategy.