What are ETFs and why are they so popular? [video]

Are ETFs the perfect solution for your portfolio?

    Should you invest in ETFs?

    This video explores the intricacies of exchange-traded funds, examines the pros and cons, and explains how ETFs may fit into your well-diversified portfolio.

    ETFs in a nutshell:

    Robin Powell: Hello there. Something that’s regularly talked about in the financial media these days is the ETF or exchange-traded fund. We’re going to take a brief look at ETFs, with the help of Hector McNeil from the ETF specialist WisdomTree.

    First of all, what exactly are they?

    Hector McNeil: ETFs trade on exchange which clearly a mutual fund doesn’t. And the benefits of that are that people can open a trade and account and trade an ETF exactly as they would a share.

    RP: ETFs have become very popular in a relatively short space of time. With more and more financial advisers now recommending them, ETF providers expect the market will continue to grow at a rapid rate. HM: Well, certainly, I think the ETF market is going through a boom, it’s almost the equivalent of the dotcom industry for asset management. And certainly, we see that this growth is going to be exponential. You know, we’re now 12 percent of mutual fund assets globally, just under 3 trillion dollars of assets, which has grown from when it was created in 2006 from half a trillion, so there is a big significant growth. I would say that we’ll see ETFs get to 30 to 50 percent of mutual fund assets.

    RP: So, how do you explain the popularity of exchange-traded funds? Well, they certainly have their advantages.

    HM: They’re usually cheap and cost-efficient. They’re very efficient for the basis of when you buy them and hold them, the cost of carrying them is very minimal. And you’ve got a significant amount of ETFs, so you got a lot of choice. You can trade everything, from equities, fixed income currencies, commodities - whatever you want, you can do, you can create your own portfolio very easily and very cheaply.

    RP: So, is it a good idea to invest in ETFs? Well, for many people, it might be. But there are three important caveats.

    First, don’t assume that just because it’s an ETF it’s going to be cheap. There are some actively managed ETFs which, over time, can work out very expensive. Secondly, remember the importance of diversification. The most effective ETFs are those which track an entire index at very low cost. And, whether you use ETFs or traditional index funds, the key is to spread your risk across different types of asset. And finally, ETFs may be easy to trade, but that doesn’t mean that you or your adviser should be buying and selling them on anything like a regular basis. Timing the market is extremely difficult and, every time you trade it costs you money.

    So yes, ETFs are an attractive option. A one-size-fits-all investment solution? Certainly not. As ever, it pays to seek independent and unconflicted professional advice.

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