What are ETFs and Index Funds?
G.R. krahmer
ETF stands for Exchange-Traded Fund. These are funds that you can trade on the stock exchange. Another word used for ETFs are index trackers or trackers, because they follow a certain index (tracking in English). In addition, there are also index funds, also called investment funds, which, like ETFs, track a specific index. With these instruments, you can easily invest in a specific index.
Such an ETF tries to achieve the same return as the market it follows. If a relevant index rises by 10%, the ETF also gains approximately 10% (not including costs). An ETF or index fund makes it easy for people, like you and me, to invest in because you are spread over the entire index with one purchase. If these trackers were not there, you would have to buy all the shares in the index one by one. The AEX index is the Dutch index and consists of the 25 largest companies in the Netherlands. If you buy an ETF that tracks the AEX index, you buy the entire AEX index at once.
The choice is huge
ETFs are available on many different types of indices. This way you have an index for shares, bonds, precious metals, raw materials and other investment categories. There is an index for almost everything, such as an index for certain themes such as sustainability, or for a specific sector such as the gaming industry. There are even more ETFs than there are individual shares.
The difference between index funds and ETFs
In general, the management costs of ETFs are lower than those of index funds. The main difference is that with investment funds you have a fixed investment time, often once a day, while you can trade ETFs at any time when the stock market is open. In addition, it is important to know that you can invest any amount in investment funds. With ETFs, on the other hand, you are usually stuck with the unit price. For example, you can invest €20 in an investment fund, but also €21 or €26, while you can purchase an ETF with a unit price of, for example, €20, so with €20 you can purchase 1 ETF and if you have €21, you can still Always buy only 1 ETF. To buy a €20 ETF twice, you need €40. Fortunately, there are often several types of ETFs for sale for a particular index with different unit prices. For example, the AEX currently has an ETF of €72.24, but also one of €6.54.
How can you invest in index funds or ETFs?
Firstly, you need an investment account/broker account to invest in this. Here we have listed the different brokers that you can choose based on your personal financial goals. After opening your investment account, you can start investing yourself almost immediately. You can see how to place your first order (buy your first investment) on the market here.
If you really don’t feel like investing yourself, it may be interesting to choose the broker based on asset management. Here too we have listed some interesting options for you.
BROKERS
What are the risks when investing in index funds or ETFs?
Index trackers or ETFs (Exchange Traded Fund) are investment products that closely follow an index. Technically, an index fund or ETF is an investment fund in which all shares of an index are included in an identical ratio. As a result, an index tracker is virtually the same as the position of an index or part of it. Index investing involves a number of risks. Make sure you have read and understood these carefully before you start investing. We have listed the risks for you below. Don’t worry, We are going to give you a checklist anyway, so that you know exactly what your risks areand you don’t have to run unnecessary risks
The risks of investing in ETFs and index funds Risks per investment category
Investments from which you can expect a higher return involve a higher risk. With lower return expectations, the risks are usually also smaller. But whatever investment category you choose, investing is never without risk; you can lose (part of) your investment.
The risks of investing in ETFs / Index trackers
Index trackers or ETFs (Exchange Traded Fund) are investment products that closely follow an index. They combine the advantages of shares and bonds with those of an investment fund. Technically, an index tracker is an investment fund in which all shares of an index are included in an identical ratio. As a result, an index tracker is virtually the same as the position of an index or part thereof. It is important that you understand the risks of index trackers before investing in them. Therefore, read the risks below carefully.
Price risk
The price of the index tracker decreases if the value of the investments in the index tracker decreases. For example, if you have an index tracker that follows the AEX, its price almost follows the position of the AEX.
Deviation from the index
You have no guarantee that the price of the index tracker follows the index exactly. For example, the price may deviate due to a lack of liquidity. For all index trackers, you will find the deviations from the index in the price information of the index tracker in My ING.
Counterparty risk
There are two forms in which index trackers track an index: physical replication and synthetic replication.
Physical replication
The publisher of the index tracker purchases the underlying securities of the index. Some issuers have stipulated in their terms and conditions that they may lend these securities (Security Lending), purchase derivatives or enter into swap agreements with them. There is always a counterparty in these transactions. Counterparty risk in this case is the risk that this party cannot meet its obligations towards the publisher of the index tracker.
Synthetic replication
The fund does not own any securities, but there is an agreement between the fund and a financial institution. There is also a counterparty risk here.
Liquidity risk
The liquidity of an index tracker can have a major influence on the costs and therefore on the return. Low liquidity can lead to problems with entry and exit and a less favorable transaction price (a higher bid/ask spread).
Currency risk
Index trackers can track funds that are denominated in foreign currencies or that are themselves denominated in foreign currencies. You may be exposed to risk due to exchange rate fluctuations of this currency. Currency effects can have a positive or negative impact on the value of your index tracker.
Tax risk
Foreign tax authorities sometimes tax (part of) the dividend. This part cannot be reclaimed, which means you will receive less dividend.
Geographic and sector risk
Do you invest with an index tracker in a specific region or sector? Then its value is sensitive to developments in that region or sector.
Sustainability risk
A sustainability risk is the risk that the value of an ETF or tracker decreases as a result of events or circumstances in the environmental or social field or because a company or country is not managed properly. When these events or circumstances occur, they can have a negative impact on the financial position of companies or countries and therefore on the ETF or tracker.
Conclusion:
Investing in ETFs or Index Funds can be very risky. If you read all those things like this, you might think: Just leave me alone. But just by understanding everything thoroughly and knowing exactly what to pay attention to, you can earn a lot of money with ETFs or Index
Funds. Some risks are unnecessary like the currency risk, synthetic replication or the geographic risk.
