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Are ETFs safe and cheap?

A friend of mine has told me about ETFs which apparently are an easy way to play the stock market, they are pretty cheap and fairly safe. Could you explain what they actually are and do you agree that they are safe and cheap?

An ETF is an exchange-traded fund and as their name implies they’re tradeable on the stock exchange. A simple one to explain might be an ETF designed to mirror the performance of the S&P/ASX 200 index. By this I’m suggesting that if you were driving home in a car and you hear on the radio that the index was up two per cent on that day, by having this ETF, you would be approximately two per cent more wealthy.

You do pay a few points to buy an ETF and this is taken by the company that bundles the 200 shares together, distributes the dividends and does the tracking of your investments. They’re cheap compared to most funds but they don’t make any decisions like fund managers apart from deciding to buy the 200 shares in the index. They’re easy to buy – you can do it online like a share or you can use a stockbroker.

Are they safe? Too hard a question! They can go up and down with the stock market and that’s the biggest risk. In a crash, they would be crushed but so would most shares.

As financial products go, I like them but not all ETFs are equal in terms of cost and safety. For example, there are resources ETFs which give you exposure to a lot of resource stocks but if the sector was caned you could lose a lot.

Some people could use ETFs to buy a whole range of sectors to get a good balance in their portfolio and buying a broad market index would also spread around your risk, though in Australia BHP, Rio, the banks and Telstra make up a big chunk of the S&P/ASX 200.

Also, investment and super funds are dearer than ETFs but one-third of fund managers beat the index, history says. So if you think you pick the best managers, remembering that the past isn’t always the best guide for the future, then a broad market index could beat two-thirds of most fund managers, if we can trust history.

By the way, good newspapers will list ETFs in the stock pages section and there will be a price for a unit. This unit is the price for getting into the ETF. It’s priced at $40 and if it goes to $50 over a year, then you have made $10 on $40 and that would be a 25 per cent gain. However, you can sell whenever you like – you don’t have to wait for a year and it’s quick to convert them to cash.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Saturday, March 05, 2011

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