ETF Investing – A Beginner’s Guide

Estimated reading time: 11 minutes

Exchange-Traded Funds (ETFs) are an amazing way to invest regardless if you are a beginner or a veteran. After analyzing ETFs for a few years now, I thought I’d make a blog post about everything you need to know when it comes to ETF investing!

Maybe you’re trying to figure out the ins-and-outs of robo-advisors who usually invest in a wide array of ETFs, or maybe you just want to learn and have no idea where to begin. Fret not, in this blog post, you’ll learn everything you need to know and maybe more!

1. What is an ETF?

ETF Investment Illustration

To put it simply, an Exchange-Traded Fund (ETF) is a diversified investment tool (a basket of stocks) to invest in a large number of companies easily. Buying or selling an ETF is similar to buying or selling a stock – but with lower volatility, that comes with a lower reward.

An ETF is effectively a hybrid between a stock and a fund because you can trade the fund on a public exchange. To make it better, they are typically cheaper because you don’t have to buy any one stock in order to own multiple companies!

2. ETF vs Mutual Fund/Unit Trust

ETF vs Other Assets

On the flipside, if you want to diversify into any particular industry or country, you can pay a fund, such as a mutual fund or a unit trust that will help you spread your money across relevant asset classes but it might come with a hefty price of around 2-5% p.a..

These types of funds are usually not publicly-listed; therefore, information regarding them could be considered scarce. At this point, it’s best to do some due-diligence before you decide to explore more into this.

3. Main Types of ETFs

You might be overwhelmed, at this point, as there are thousands of ETFs out there, and they can be categorized into these 5 main types:

• Stock/Equity ETFs – Stock/Equity ETFs usually track the performance of a bunch of stocks that can come from different industries, countries, market caps, value, or growth-based, etc. There are a ton of combinations and the sky’s the limit.
• Bond ETFs – Bond ETFs are a great way for retail investors to get exposure towards the bond market or fixed income instruments. Individual bonds are usually more expensive and can cost upwards of a few hundred thousand US dollars. With Bond ETFs, you can invest in a diverse amount of bonds.
• Commodity ETFs – Commodity ETFs are ETFs that allow you to invest in various commodities such as gold, silver, soybeans, crude oil, livestock etc. Historically, investors have invested in commodities as a way to hedge against inflation.
• Currency ETFs – Currency ETFs enables you to invest in a single currency or a basket of currencies, which is also a common strategy for investors to hedge against currency risks.
• Specialty ETFs – Specialty ETFs can come in the form of inverse or leveraged funds. To make it simple, inverse funds allow you to bet against or “short” certain asset classes. Leveraged funds allow you to amplify your gains and losses by a multiple of 2x or 3x. As general advice, it’s not recommended for beginners to touch this type of ETF until you know what you’re getting yourself into.

4. Active vs Passive ETFs

ETF Management can be further split into either active or passively managed ETF. To simplify things:

• Active ETFs – Active ETFs are actively managed by a fund manager, usually on a daily basis. In hopes of getting better returns, fund managers actively trade for you. In return, you’ll have to pay them a fee of usually around the ballpark of 0.5% – 1% p.a.. The returns are usually either above or below average, depending on the fund manager’s capabilities. A good example of an actively-managed ETF is Cathie Wood’s ARK ETF.
• Passive ETFs – Passive ETFs are passively managed by a manager that doesn’t do too much other than track the movements of a certain index, such as the S&P 500. Hence, the fees that they will charge are typically much lower than Active ETFs, about 0.10% p.a.. However, despite this, the returns of passive ETFs are usually pretty average, not bad at all.

5. How do you find an ETF that is suitable?

Now that you get the idea of what ETFs are, let’s take a look at how to find the right ETF for you. As a general rule of thumb, you should always take a look at their fact sheets, and to be frank, the easiest way to do so is by Google-ing them. If you want to learn more about Cathy Wood’s ARK ETF, you can google “ARK Invest Fact Sheet”. You should have access to the fact sheet, which is a publicly available document.

ETF Fact Sheet Search

However, if you don’t really have any specific ETFs in mind, you can always check out ETFdb.com – which is an awesome website for you to screen any ETFs. Alternatively, you can take a look at justETF.com, which allows you to scan ETFs outside of the US.

Just ETF has a screener that can help you filter ETFs according to your parameters. For instance, if you choose “S&P” under the Index Family, you’ll be able to see a bunch of S&P 500 ETFs that are traded under different currencies and exchanges.

Furthermore, you can also be more specific and select different sectors within the S&P Index Family. For example, you could further filter and look for “S&P 500 Consumer Staples Sector”. By doing this, you are able to pin-point the ETF that you might be interested in, as well as download the fact sheet so that you can do further research.

6. How do I break down ETF Fact Sheets?

After briefly mentioning ETF fact sheets, let’s break down the 11 main parameters that you should be focusing on:

ETF Fact Sheet Breakdown Pt 1.

ETF Fact Sheet Breakdown Pt 2.

ETF Fact Sheet Breakdown Pt 3.

1. Fund’s Investment Objective – The fund’s objective tells you what the main theme is for the ETF. It’s usually located in the first page of the fact sheet, and it tells you what you are getting exposed to. For example: the Ireland Domiciled S&P 500 ETF tells you that “The Fund seeks to track the performance of an index composed of 500 large caps U.S Companies.”
2. Underlying Assets / Top Holdings – The fact sheets usually show the composition of the top 10 holdings with the highest weightage in that particular ETF. When it comes to analyzing an ETF, it’s always good practice to have some sort of understanding of the top 10 holdings, as they typically comprise a relatively big chunk of the entire ETF’s holdings.
3. Sector & Geographic Breakdown – The sector breakdown shows you the exposure of the ETF towards any particular industry. On the other hand, the geographic breakdown shows you the weightage of your exposure towards any particular country, and this is most significant when talking about ETFs that are exposed to a variety of countries like the All-World ETF.
4. Expense Ratio – For passively-managed ETFs, the expense ratio could be as low as 0.03% (reference: VOO ETF). Let’s dissect the expense ratio formula, which is the total fund costs divided by total fund assets. The fund costs incurred by a fund manager will include transaction fees, regulatory fees etc. For an actively managed ETF, there are typically a lot more buy & sell transactions, which makes sense since the expense ratio will increase significantly. Fees are usually automatically deducted from your returns, there is no need to pay anything separately.
5. Fund Performance – Fund performance is typically illustrated in time blocks, ranging from months to years to “since inception”. This is further broken down into Net Asset Value (NAV) & Market Price. NAV represents the total value of the underlying asset + cash, which is calculated by the accountant at the end of each trading day. Market price refers to the ETF’s trading price in a stock exchange that varies according to the Bid & Ask price so it changes every single second during the course of the entire trading day. Disclaimer: Past performance doesn’t guarantee future results, so I recommend that you don’t invest into any ETFs based on past performances alone.
6. Distribution Policy – Distribution Policy usually comes in the form of distributing or accumulating. This information is available on the fact sheet, but if not, the name of the ETF itself should be a clear indicator. Accumulating ETFs automatically reinvest any dividend, so you won’t be receiving any dividend payouts, but it will be reflected in the capital gains growth of the ETF’s share price. Distributing ETFs will pay dividends, usually every quarter. In the case of all US Domiciled ETFs, they are all distributing ETFs only because they are required by US Regulations to distribute at least 90% of its income to its shareholders. If you are a fan of passive income, distributing ETFs could be the one for you; but if you prefer to let the ETF reinvest for you, accumulating ETFs are the way to go.
7. Trading Currency – Just like stocks, ETFs are traded on an exchange, but they might only have a few trading currencies associated with them. The best way to identify them is by checking it on their fact sheet. You can also differentiate them by their ticker symbols. For example, the iShares Core S&P 500 UCITS ETF is broken down into CSPX & CSP1. The former is traded in USD whereas the latter is traded in GBP. Their returns are more or less identical, so choose the one that is most convenient for you.
8. Trading Volume / Liquidity – To make it easier for you, liquidity essentially means how many investors are trading this ETF, and in most cases, the higher the liquidity, the better. For this section, you may or may not find it on the fact sheet, but you are able to look it up on other sources such as Google Finance or Yahoo Finance. A fund that has a higher trading volume or higher liquidity will have a lower bid and ask spread. Since there are more buyers and sellers, you will be able to buy and sell it more easily at a price that is more favorable for you. This is more relevant to investors who are actively trading ETFs as opposed to investors who prefer to hold ETFs long-term.
9. Fund Domicile – Fund domicile means where the fund is based. Depending on where the fund is domiciled, you will have to pay their taxes accordingly. The Vanguard S&P 500 ETF (VOO), which is arguably the most popular ETF out there, is based in the US. This means that you’ll have to pay the 30% dividend withholding tax if your country does not have a tax treaty with the US. If you are investing in Ireland domiciled ETFs such as CSPX, you will be subjected to Ireland’s 15% withholding tax instead.
10. Listing – This essentially means which exchange this ETF is being traded on. This is important because depending on your brokerage platform, you might need special access to certain stock exchanges that might not be immediately available to you. Fortunately, Interactive Brokers (IBKR), which is my favorite platform, has a wide array of exchanges all around the world for you to choose from. There’s no minimum funding amount, and there are no inactivity fees, too!
11. Replication Methodology – This can be broken down into physical replication and synthetic replication. Physical replication essentially means that the ETF will physically hold the stocks that they are trying to track. Whereas synthetic replication will replicate the stocks they are trying to track using financial derivatives such as using swap contracts between the fund & a counterparty such as a bank. Synthetic ETFs tend to have a lower level of transparency and are counterparty risks, such as banks committing fraud etc. I would personally recommend physical ETFs as opposed to synthetic ETFs in this regard.

7. Conclusion

To conclude, ETFs are an awesome way to diversify your portfolio, but it’s also important to do some due-diligence in order to know what you are getting yourself into. I hope that you’ve enjoyed reading this article, but if you prefer it to be in a video format, you can check out my video about ETF investing here:

You can also start investing in ETFs & Stocks using Interactive Brokers. In my experience, they are one of the best, if not the best brokerage platforms on the market. I’ve personally been on their platform since the beginning of my investment journey. I would highly recommend it to anyone that’s looking to start investing! You can also check out my guide here, on how to set up your very own Interactive Brokers account!