How do I use ETFs in an investment portfolio?
Exchange traded funds (ETFs) can help to build a well-balanced investment portfolio and are suitable for investors with all kinds of objectives.
ETFs aim to replicate the performance of a particular index or asset by investing in its component parts.
A standard S&P ASX 200 index ETF, for example, would effectively give you exposure to the 200 companies that make up the index through a single trade and for a tiny proportion of the cost of investing in them directly.
You can get ETFs that aim to track indexes in:
- Shares in countries and regions all around the world, e.g. US, Japan, Asia or Europe
- Shares sectors or themes, e.g. financials, resources, small cap or high yield
- Other asset classes, e.g. bonds, property, commodities (silver, gold or wheat)
They are listed on the stock exchange and can be bought and sold like shares.
How can you use them?
One of the key benefits of ETFs is diversification, which helps reduce investment risk.
Because they provide access to all of the major asset classes, you can use ETFs to help you build a well diversified portfolio.
For example, you could invest in ETFs that track the performance of the following:
- Australian shares
- US shares
- Emerging market shares
- Australian bonds
- Australian listed property
Picking a theme
You might already have a balanced portfolio of investments but spot a particular theme or market that you think is likely to perform well in the future, for example European shares or small cap companies.
You may not wish to try and select individual companies that might benefit from such a theme, so an ETF can give you broad access instead.
Of course, you can also invest in ETFs alongside direct investments.
For example, an ETF that tracks the ASX 200 index could be used to gain broad market exposure, offsetting some of the risk that comes with individual stock selections.
- If you invest in an ETF that tracks an index which grows at 8%, then you’ll get a return around that mark, but if you invest in individual assets within that index, you could gain or lose much more.
- ETFs will not perfectly replicate the price performance of the index or assets they track due to fees, taxes and other factors. This is known as 'tracking error'.