If you’re new to investing making your first investment can be daunting.

Sure, you can look on the internet for guidance, but this can make it worse. With so many conflicting opinions out there, you don’t know who to trust. 

This is where Exchange Traded Funds (ETFs) have come in handy for new investors. Their ease of use and instant diversification make them a no brainer for new investors. In fact, according to the latest ASX Investor Study Australia, 15% of Australian new investors choose ETFs as their first investment. 

This blog will highlight five essential points you should be aware of before making your first ETF investment.  So, before you dive in lets get around a few basics. 

1. An ETF is an Investment Structure 

The first thing I want you to get your head around is that an ETF is an investment structure. The term Exchange Traded Fund is a blanket term for many different investments. 

Let’s use cars as a simple analogy. Go to any main road and you’ll see a lot of different cars driving arounds – sports cars, station wagons, four-wheel drives, hatchbacks and so on – all of them have their own characteristics and features – but they’re all still cars.  They’re getting people from A to B.  

Just like cars there are literally hundreds of ETFs to choose from and not every ETF is going to be right for you. 

Always remember that ETFs aren’t all the same and that each ETF will perform differently so ýou can’t just lump them together as one investment.  Before you buy an ETF, make sure you look under the hood. 

2 An ETF is a Collection of Investments 

The second thing I want you to get your head around is that an ETF is a collection of investments.  Think of an ETF as a basket or some other container if you need to.    

The interesting part is that your ETF collection is only created when you make your purchase.   Which means the price you buy it for is your starting point. This starting point is the basis for any capital gains or dividends you receive.   

Another thing to remember is when you buy an ETF, you’re often not buying 1 of every underlying asset within the ETF.  What you’re buying is a proportion of each underlying asset within that ETF.  As an example, you can currently buy an ETF that has exposure to the largest 200 companies in Australia for less than $70, but $70 is less than the price of one Commonwealth Bank Share. 

So let’s recap. An Exchange Trade Fund is an investment structure.  Each ETF holds a collection of underlying investments within it.  And each individual ETF is made up of a proportion of the underlying investments.

3. What type of investments go into each collection? 

In Australia, ETFs are bought and sold via the Share Market or the Australian Stock Exchange (ASX) to be more accurate. Although ETFs are purchased on the share markets, that doesn’t mean they only invest in Australian Shares. 

One of the major benefits of ETFs is they allow you to invest in a range of other asset classes.  

You can buy ETFs through the ASX that invest in International Shares, Property, Australian and International Bonds and Cash. To make it even easier, you can buy an ETF that invests in all of the different asset classes within the one investment. How easy is that?

ETFs conveniently allow investors to choose the collection of assets they would like to invest in.

4. What affects the Price of an ETF? 

The next thing I want you to get your head around is ETF pricing.  

There has been so much positive press around ETFs in the last few years that a new investor could be forgiven for thinking that ETFs are special and somehow separate from their underlying investments and immune to market fluctuations. 

This is a misconception 

I want to dispel this sooner rather than later. In reality ETFs, and especially share-based ETFs, are directly impacted by market movements. 

The price of an ETF is based on the value of all the underlying investments it contains.  If the majority of the underlying investments increase in value, the price of the ETF is going to increase in value. If the value of the investments go down, the price of the ETF will also go down. 

Always remember the core factor driving an ETF’s price and performance is the underlying investments and that the underlying investment values are not static and are always subject to change. 

5. What Type of ETFs are Available?

ETFs have become very popular in Australia. More than 300 ETFs already exist, with more being released each month. This can be overwhelming for new investors, so in this section I am going to run through what I consider to be the three basic types of ETFs available to Australian investors - Index Funds, Thematic Funds, and Actively Managed Funds.   

The original and easily the most popular ETF type is Index Funds.  ETFs are synonymous with Index Funds. Index Funds track a specific market index, they provide broad market exposure with very low fees.  For example, there are Index Funds that track the largest 200 companies in Australia, and the largest 500 companies in the USA. 

Thematic Funds, on the other hand, focus on specific themes or sectors. They allow investors to align their investment choices with their interests and beliefs. An example of this might be an ethical ETF that provides exposure to companies active in climate change, or a technology fund that focuses on Robotics or Artificial Intelligence.  

The third type are Actively Managed Funds.  They involve a hands-on approach from fund managers who make strategic decisions to outperform the market. When you are investing in an Actively Traded Fund you are really investing in the skill of the manager and your belief in their investment selection. 

For those starting out, the simplicity and cost-effectiveness of Index Funds make them an ideal choice. These funds offer a diversified portfolio that mirror the overall market’s movements and are a solid core foundation for both new and experienced investors.  

Let’s recap. 

•  An Exchange Trade Fund is an investment structure.  
•  Each ETF holds a collection of underlying investments.  
•  Each individual ETF unit contains a proportion of the underlying investments, not one of every investment.  
•  An investor can invest in an Index Fund, Thematic Fund, or Actively Managed Fund, which provide access to a range of different asset classes - not just shares.  
•  An ETF’’s value is going to fluctuate in line with the performance of its underlying investments. 

Hopefully, that has made investing in an ETF a little clearer for a newbie investor. 

If you would like to discuss any of the ideas raised within this blog I can be reached at [email protected]

This blog’s aim is to provide general information only. It should not be relied upon as personal financial advice. While all care was taken at the time of writing, I make no representations as to the accuracy, completeness, suitability, or validity, of any information contained within.  The ETF Guy strongly recommends investors consult a financial adviser prior to making any investment decision.