What is an ETF?
What are ETFs and how are they useful?
Inflation is currently at record levels. Although the European Central Bank (ECB) has already raised interest rates, many people will clearly feel the depreciation of their currency. However, as an investor, it is entirely possible to beat inflation with ETFs by investing in ETFs. So what exactly are ETFs? What does the abbreviation ETF stand for? Passively managed index funds have been convincing investors for many years with their low costs and attractive return potential . It is therefore not surprising that the volume of investments in this form of investment is constantly increasing and that the ETF savings plan in particular has become a popular means of long-term asset accumulation.
We show you what ETFs are and how they work. You’ll also find lots of interesting information about exchange-traded funds.
- Definition: ETFs (Exchange Traded Funds) are exchange-traded index funds that passively track the performance of their underlying index.
- Costs: ETFs are passively managed, so management fees incurred are low compared to actively managed funds. ETF costs are typically between 0.35% and 0.5% per year.
- Yield: Compared to traditional forms of savings such as term deposits or savings accounts, investing in ETFs offers the possibility of higher returns.
- ETF investment plan: With the help of a savings plan, it is possible to invest in ETFs with low monthly payments. In this way, investors can benefit from the cost averaging effect.
- Risk: ETFs are relatively low risk compared to individual stocks. By including a variety of securities and asset classes in the portfolio, the risk of the investment can be widely diversified.
What are ETFs?
Short for Exchange Traded Funds , ETFs are, by definition, exchange-traded index funds that passively track a specific index, such as the German Stock Index (DAX) . The performance of the ETF therefore parallels the performance of the relevant underlying index.
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The term fund comes from the French and means capital. Therefore, mutual funds are used to invest money and capital. But unlike buying stocks , funds pool the money of many investors and use it to buy a “bouquet” of different securities (e.g. stocks, bonds, or real estate). ETFs are a special type of fund. The exact term behind the acronym, Exchange Traded Funds, sheds light on the exact meaning of an ETF. ETFs are exchange-traded funds that track a specific index, such as the MSCI World Stock Index.
However, like other investments in the capital market, investing in ETFs carries higher risk. On the other hand, investors can earn higher returns with ETFs compared to traditional savings products such as savings accounts or term deposits. Another advantage of ETFs is that they have lower costs compared to actively managed funds or stocks.
How did ETFs come about?
The idea of creating an ETF dates back to 1900. The first ETFs as we know them today finally came onto the market in the 1990s in the United States. They should minimize the risk of losses in the stock market by diversifying investments . This situation and the fact that ETFs can be easily accumulated by people who do not yet have much experience in the stock market made ETFs popular in Europe in a short time. Since then, the annual capital invested by investors in ETFs clearly shows that index funds are becoming more and more popular.
Are ETFs a fad?
ETFs, index funds, active funds… What’s the difference?
ETFs are passively managed , meaning that the performance of the ETF automatically tracks the performance of the underlying index. However, they should not be confused with passive index funds. The main difference is that they are traded on an exchange. In a passively managed index fund, the price is determined only once a day. All purchases and sales are then made at this rate. On the other hand, investors can track the price of an exchange-traded ETF in real time and react to price developments during exchange opening hours.
Unlike ETFs and other passive index funds , active funds are managed by a fund manager . The fund manager tries to outperform the market by buying and selling funds in the investor’s best interest. However, various studies show that active funds rarely outperform the underlying benchmark when looking at short- and long-term horizons.
Because ETFs don’t require fund management, exchange-traded index funds are significantly more cost-effective. These lower costs have a positive impact on performance. You can read more about the differences between funds and ETFs in our guide .
Difference between ETFs and individual stocks
Whether investing in individual stocks or ETFs is the right strategy for you depends on your individual goals and risk appetite . Investing in individual stocks generally carries a higher level of risk. Unlike ETFs, which are already diversified on their own, the risk isn’t spread out as broadly with individual stocks. For example, ETFs track the performance of multiple companies, while stocks invest in a specific asset.
Also, unlike stocks, ETFs and index funds are considered private assets, meaning that the assets invested are protected by law and are not lost in the event of bankruptcy of the fund company. For stocks, there is a risk that the entire investment will be wiped out.
Total losses are not uncommon for individual stocks. According to a study by investment firm Flossbach von Storch, 20% of all stocks in Germany lost between 90% and 100% of their value between 2003 and 2020. Funds are therefore fundamentally advantageous for every investor, whether active or passive, as they offer a very broad range of diversification.
How do ETFs work?
As an investor, you can open a securities account with different providers and use it to buy shares of selected ETFs. ETFs evolve according to the evolution of the securities included in the ETF . If the underlying index rises, the ETF makes a profit and the shares can be sold with the proceeds. If the index falls, the ETF also loses.
To replicate the index as accurately as possible, providers use different replication methods. An ETF can replicate an index in two ways: as a physical index replica or as a synthetic index replica. These mechanisms ensure that the ETF always behaves exactly like the index. Physical replication, where the securities included in the index are also held in the ETF, is particularly popular with investors.
In synthetic replication , the ETF does not invest directly in the stocks it contains, but the index is replicated by the ETF through an exchange transaction (called a swap). Both replication methods have their advantages and disadvantages. Which method is best for you depends on your individual investment goals and risk tolerance .
Mapping CAC40 ETF indices
CAC40 shows the performance of the 40 largest publicly traded companies .
ETFs offer investors the benefit of full transparency, as the composition of the underlying index is publicly available . Depending on the replication method chosen, ETFs can invest directly in the same stocks that make up the CAC40 index (physical replication). This way, investors always know exactly where their money is invested.
What other ETFs should I invest in?
Depending on your personal investing approach, ETFs can be divided into different themes and categories. For example, it is possible to invest in the following ETF categories:
- Asset Class ETFs (Stock ETFs, Bond ETFs, Commodity ETFs)
- Thematic ETFs (ETFs on topics such as medical technology, healthcare, digitalization, technology)
- Sector ETFs (energy, financials, consumption, etc.)
- ETFs for regions or countries (e.g. Europe, Asia, emerging markets)
- Specialized ETFs like commodity ETCs, crypto ETNs, etc.
What are the best ETFs?
Vanguard FTSE All-World ETF is a global ETF that includes nearly 4,000 stocks. It stands out with its 5-year return of 74.7%. The HSBC MSCI World ETF includes nearly 1,500 stocks from developed markets. Its 5-year return is 82.6%. However, investors who want to invest in emerging markets have been able to achieve a 5-year return of 47.44% in the past, for example, with the iShares Core MSCI EM IMI ETF (as of January 17, 2022).
Find today’s best ETFs for global stocks in the table and our ETF recommendation lists.
Best ETFs for investing in global stocks
ETFs are very important for investors because they make it easy to invest across markets and diversify investments across asset classes . Their multiple benefits are based primarily on:
- Lower costs
- A transparent and flexible system
- Some security as special assets
- A widely distributed risk
ETFs are ideal for implementing a personal investment strategy and can even be used as an investment plan. Any investor can get the most out of their ETF portfolio by monitoring the progress of their investment with the help of a financial advisor.
Our answers to frequently asked questions
Why should you invest in ETFs?
There are many advantages to investing in ETFs. ETFs are passively managed, which means lower costs and fees for investors . ETFs also have a transparent structure , allowing an individual to diversify their financial investments . Compared to traditional savings forms such as a savings book or daily savings account, ETFs are also suitable for long-term retirement planning due to their returns.
Do ETFs always hold all the securities that are part of an index?
The answer to this question depends on how well the ETF tracks the underlying index. In the case of a physical ETF, the stocks included in the index are also represented in the ETF. On the other hand, in the case of a synthetic replication, the ETF invests in swaps and there is a transaction called a swap transaction.
What asset classes are there ETFs for?
When it comes to ETFs, stocks are the primary asset class. However, bond ETFs and real estate ETFs are also common asset classes. There are also portfolio ETFs. These multi-asset ETFs combine multiple classes of securities, thus spreading risk across multiple asset classes.
Is an ETF in MSCI World worth investing in?
An ETF in MSCI World is especially suitable for beginners. Even an ETF investment plan with a fairly low monthly investment amount is sufficiently covered by MSCI World. On the other hand, if you want to make a larger investment , for example 50,000 euros , you should diversify and add more ETFs.
Should you pay constant attention to your ETF?
Once you define a strategy and implement it with ETFs, you have already done most of the work. Especially if you have created an ETF investment plan, you will automatically and regularly invest a certain amount in your portfolio. About once a year, you should check how the value of your ETFs has changed. Patience is key: if an ETF does not perform well for a short period of time, a change in its value after a few months can already present opportunities for returns.
