You no longer feel like leaving your money in a current account with a low interest rate (or your piggy bank). So you're thinking about investing money, but what options are there?
You can, for example, decide to buy a certain share, e.g. one Tesla share. It may well be that the share price is developing well, so the price of your share has risen and you can get a profit on the sale. That said, the price can go the other way and you're making a loss. Stocks perform better on average than stocks, but that's why the risk you take is also higher. So it is better to be sure that when you buy a share there is a good reason for it (e.g. analyzing financial reports) and not just speculating. And there are also very high transaction fees when buying shares ...
Due to a justified caution regarding active investment (e.g. specifically buying a stock to try out the market), the popularity of so-called ETFs has increased significantly in recent years. You may know the name, but what is it and why are ETFs good for investors who want to invest long term?
1. ETFs have a strong tailwind
ETF’s, short for Exchange Traded Funds, are exchange traded index funds.ETFs track the performance of a particular index, such as the S&P 500 or the DAX®. They allow you to invest in entire markets at low cost and, in addition to stocks, a wide range of asset classes, such as bonds or commodities, are available. That means you don't have to decide to invest in a certain asset, but you invest in an entire market. ETFs therefore offer the possibility to invest in many different assets and asset classes via one product in order to obtain maximum diversification (i.e. spread your risk). To continue our example from earlier, instead of buying a Tesla stock, you would buy a NASDAQ-100 ETF so that you are not only exposed to Tesla but also to other 99 US tech stocks (e.g. Netflix, Apple). In the event where the Tesla stock would drop 10%, the value of your investment would fall less since it also depends on the performance of other 99 stocks.
The first ETF’s were created in 1996 and have grown enormously in popularity since then. The market continues to grow every year, in 2003 there were just 276 ETFs, in 2018 there were already 6,478. Worldwide, around $ 5 trillion are landed in these ETF’s, with the largest share in the United States. With so many ETF’s, of course, the variety of products available to a customer increases. Another positive effect is that the widening of ETFs has reduced costs significantly.
2. But why is an ETF so cheap?
There are several reasons why ETF’s running costs are so low. On the one hand, ETF’s only track a benchmark. B. spent on research staff, analysts and accountants, significantly lower than e.g. with an investment fund. The issuer is not involved in every transaction. You can imagine it like Tesla, they are not involved when their shares are bought or sold, nor is the ETF publisher involved in this process. Another factor for the low price is the fact that they are traded on the stock exchange, which naturally also eliminates many operating costs that would normally have to be borne by a regular investment fund.
3. Are there any important differences to watch out for?
There are basically two ways that an ETF can track an index.On the one hand, he can actually buy all the values contained by a physical illustration. On the other hand there are synthetically replicating ETFs, so-called swap ETFs, where the index is replicated via a swap transaction. The ETF concludes a contract with another financial institution that undertakes to deliver the index return in exchange for a fee.
The synthetic ETF does not necessarily have to contain the same securities as the replicated index, for example an ETF on American securities in the collateral portfolio can also contain European securities, which is why they are mostly used in very broad and illiquid markets in order to track them more efficiently and better. It has to be said, however, that the market for synthetic ETFs has declined enormously in recent years. This is due to the risk associated with the financial institution in the event that it can no longer meet its obligations. This is why most issuers now use physical replication.
4. Ok and what now?
In summary, ETF’s are the best way to invest in entire markets via a product, to diversify broadly and to generate a nice return without much effort. They are very inexpensive, are traded on the stock exchange and are very transparent with regard to costs and allocation. But you have to say that these products become more and more complex over time. Many private investors have problems keeping track of all the product variety. It is therefore advisable for anyone who is not thoroughly familiar with the products to deal intensively with this topic (but this can be time-consuming) or to choose a consultant (physically-but expensive, or digitally via an app).
You are a new investor and would like to know which ETF’s best suits your risk profile, then you are welcome to drop by and try our free app. In 3 minutes we will help you invest money independently. And if you are not yet ready to do so, feel free to take a look at our blog 😊