Exchange Traded Funds are also known as Index Funds and are listed index products. ETFs are traded on an exchange just like any ordinary share and the price of a particular ETF will be determined by the demand and supply of the ETF.
An ETF is defined as a listed investment product, which tracks the performance of a particular index (e.g. FTSE/JSE Top 40 Index) or a “basket” of shares, bonds, money market instrument or a single commodity.
One ETF gives you exposure to a portfolio of investment instruments and not just one investment instrument. If you for example want to own shares of the Top 40 companies listed on the JSE, you can simply buy the ETF that tracks the Top 40 index instead of buying shares of the individual companies. Owners of an ETF are also eligible to receive dividends should the securities in the tracking index pay dividends.
Unlike Unit Trusts, ETF fund management does not require a great deal of research and decision making. The index fund manager merely has to buy and sell the underlying investment instruments of the index in the ratios which exactly replicate the index.
Most of the ETFs listed on the JSE are also registered as Collective Investment Schemes (CISs) / Unit Trusts and are well regulated by the JSE and the Financial Services Board (FSB)
Usual JSE dealing cost apply when you buy ETFs through a stockbroker (i.e. brokerage fees, Strate fees and the investor protection levy). Note that ETFs are exempt from the 0.25% Securities Transfer tax (SST) upon purchase of the ETF.
The prices of the underlying investment instruments of the ETF are subject to market forces and will therefore fluctuate. The price of the ETF will therefore also fluctuate. The risk of losing money is however lowered because of the advantage of a diversified portfolio.
Capital gains (profits) from the sale of an ETF are subject to Capital Gains Tax.
ETFs are a very simple and low cost investment products which can easily be bought and sold in the same way as an ordinary share. The ETF gives investors exposure to a variety of securities and or assets and investors buy into an already diversified portfolio.
ETFs are especially ideal for the beginner investor who is still learning and who has limited capital to build a diversified portfolio. The small investor will with his / her first small purchase / investment, own an already diversified portfolio.
There is really nothing to stop the beginner to start tapping into the wealth creation available through the stock market and readers are encouraged to get involved. Real wealth creation requires time and patience and the advantage of starting early to save and invest is emphasized again.