Are you a Malaysian investor looking to diversify your portfolio but don’t have the time to analyse stocks?
Perhaps you have heard that ETFs could meet your needs for diversification without additional work, but aren’t sure how they work.
We can understand – a lot of Malaysians are in the exact same position as you are in right now.
While ETFs have existed since the 90s, in Malaysia this is a relatively ‘unknown’ asset class compared to stocks, and unit trusts.
This is why we decided to create this guide: A Super Simple Guide to ETFs, meant to be understood by beginners with zero investing experience.
Let’s start by understanding what exactly are ETFs, and what makes them so special, especially for busy investors.
What is an ETF?
Exchange-traded Funds or ETFs are a mouthful to say compared to stocks and unit trusts, but the fundamental idea is pretty straightforward.
You can think of ETFs as a special kind of basket that holds many different things.
Imagine you had a box that could hold all your favourite snacks. An ETF is similar, but instead of snacks, it holds small pieces of different companies or things called stocks.
Let’s say you love chocolates, and in your snack box, you have little pieces of different types of chocolates.
Just like that, an ETF can hold little pieces of different companies from various industries like technology, clothing, or food. This way, when you own an ETF, you are actually owning tiny parts of many different companies at the same time.
How Do ETFs Work?
ETFs copy an index by owning a mix of securities that represent it. By owning shares in an ETF, investors gain exposure to a wide range of investments without having to buy shares from each company separately.
For example, if an ETF is designed to track the S&P 500 Index, it will hold all or most of the stocks within that index in proportion to their weightings.
How are ETFs Bought and Sold?
ETFs are bought and sold on stock exchanges much like individual stocks. Buying an ETF is similar to purchasing regular shares of a company.
In other words: quite easily. Especially if you already have experience buying and selling stocks.
It’s useful to note that not all ETFs are available on Malaysian brokerage platforms, however. Global ETFs are usually found on platforms such as Interactive Brokers.
Why were ETFs created?
ETFs, or exchange-traded funds, were created in the 1990s with the aim of providing investors with a more efficient and convenient way to gain exposure to diversified portfolios of stocks without having to pay fund managers a high fee.
Before ETFs came into the picture, investors who wanted a more diversified portfolio had to buy products like unit trusts, whose high fees make them pretty expensive.
Who created ETFs?
ETFs were first introduced in the early 1990s by two individuals in the finance industry named Nathan Most and Steven Bloom.
Most was a managing director at the American Stock Exchange (AMEX), while Bloom worked as an attorney specializing in investment funds.
They created ETFs as a financial product that combined the diversification features of mutual funds and the flexibility and tradability features of individual stocks.
The first ETF they launched was the Standard & Poor’s Depositary Receipts (SPDRs) – also known as SPY – in 1993. This ETF aimed to track the performance of the S&P 500 index. Over time, ETFs were created for other asset classes like bonds and commodities.
The different types of ETFs in the market today
There are many types of ETFs available in the market today. The most popular ones include:
1. Equity ETFs: These ETFs track specific stock market indices like the S&P 500 or in Malaysia, the KLCI index. By holding a proportional weightage of the constituent stocks, equity ETFs aim to replicate the performance of the underlying index.
2. Bond ETFs: These types of ETFs invest in a portfolio of bonds with varying maturities and credit qualities.
3. Commodity ETFs: These provide access to commodities like gold, oil, natural gas, or agricultural products. They work by holding physical assets or using futures contracts to track the price movements of commodities.
4. Currency ETFs: Currency ETFs allow investors to gain exposure to various currencies without having to directly participate in the forex market.
5. Sector-specific ETFs: These ETFs hold industry or sector-specific stocks. For example, the iShares Semiconductor ETF tracks the performance of select companies within the semiconductor industry.
6. Region or Country-specific ETFs: These provide exposure to specific markets based on geography. These ETFs allow investors to gain exposure to markets outside of their home country.
What are the advantages of ETFs?
There are many benefits of investing in ETFs, namely
Diversified portfolio
The biggest advantage of buying ETFs is that they offer investors exposure to various asset classes and market sectors without having to buy individual stocks or bonds.
Lower cost
ETFs typically have lower expense ratios compared to actively managed mutual funds since they aim to replicate specific indexes rather than requiring active management. This allows investors to gain broad market exposure at a relatively low cost.
Higher liquidity
You can buy and sell ETFs on the stock market, making them more liquid compared to unit trusts, which typically take between 7 and 10 days to cash out.
Higher transparency
Furthermore, ETFs offer transparency as their holdings are disclosed daily, enabling investors to see exactly what assets they own. This facilitates informed decision-making and allows for better alignment with investment objectives.
Global exposure
Additionally, with many ETFs available covering various asset classes and sectors globally, investors can easily access specific markets or industries that suit their investment strategy.
Should Beginners Invest in ETFs?
As you have seen, there are many benefits of investing in ETFs. Their features make them specifically suited for new investors.
Compared to individual stocks which require substantial research time, ETFs require minimal research. This makes them well-suited for individuals who may not have enough time or experience to conduct stock analysis.
ETFs also allow investors to have a well-diversified portfolio with a small investment. This flexibility allows new investors to gradually increase their investment over time.
Unlike Unit Trusts, the price for ETFs are also more transparent, allowing investors to check the status of their portfolio anytime they want.
Conclusion
In conclusion, beginners can benefit from investing in ETFs due to their simplicity, accessibility with limited capital requirements, transparency through daily disclosures, and availability of educational resources.
Overall, due to their diversification benefits, cost-effectiveness, transparency, tax efficiency, accessibility to different markets/industries and flexibility in trading options – ETFs have become increasingly popular investment vehicles among investors seeking a balanced approach with optimized control over their portfolios.