An exchange-traded fund (ETF) is designed to track the price movement of a chosen index such as the S&P/ASX 200 in Australia or the NZX 50 in New Zealand. Typically, an ETF is made up of a basket of stocks that closely match the index the ETF is following.
ETFs can also track the price of a single commodity, such as gold or silver. Not all ETFs are created equal, though. Before you dive in, you need to know what you’re investing in and the risks and benefits of each type of ETF.
ETFs track an index in one of three ways, each with different characteristics:
Physical holdings: The ETF invests in the underlying stocks of an index and the ETF’s performance largely matches the index.
Synthetic replication: The ETF uses futures and options to track an index’s performance, without actually owning the stocks in the index.
Optimised sampling: Only the major stocks in an index are owned directly — the idea being that you don’t need to own all the stocks in an index to achieve the same performance.
At first glance, an exchange-traded fund (ETF) may seem identical to a managed fund. After all, like ETFs, managed funds also represent baskets of stocks or bonds. The two, however, are not twins. They’re not even siblings. Cousins are more like it. Here are some of the big differences between ETFs and managed funds:
ETFs trade differently. They can be bought and sold, and their price changes, throughout the day. In contrast, managed funds are typically not listed on the Australian Securities Exchange (ASX) or New Zealand Stock Exchange (NZX). You have to contact the fund manager directly (or your financial adviser can do it for you) and usually complete a form to buy or sell managed fund units. The price you receive is the value of the fund at the close of business that day.
ETFs are cheaper. They require you to pay small trading commissions, but ETFs usually wind up costing you much less than a managed fund because the ongoing operating expenses are usually much less. Most ETFs charge no more than one-half of 1 per cent per year, some less than one-tenth of 1 per cent. New Zealand is the exception where ETFs costs range between 0.65 and 0.75 per cent per year.
ETFs tend to track indexes. Managers of ETFs tend to do very little trading of securities in the ETF. The vast majority of managed fund managers spend a lot of their time trading.
ETFs can result in less tax. Because of low portfolio turnover and also the way they are structured, ETFs’ investment gains usually are more gingerly taxed than the gains on managed funds.
The following table highlights the main similarities and differences between ETFs and managed funds.
| ETFs | Managed Funds | |
|---|---|---|
| Priced, bought and sold throughout the day? | Yes | No |
| Offer some investment diversification? | Yes | Yes |
| Minimum investment required? | No | Yes |
| Purchased through a stock broker? | Yes | Sometimes |
| Do you pay a fee or commission to make a trade? | Yes | Yes |
| Can you buy/sell options? | Yes | No |
| Indexed (passively managed)? | Typically | Atypically |
| Can you make money or lose money? | Yes | Yes |
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Source:http://www.dummies.com/how-to/content/investing-in-exchangetraded-funds-in-australia-and.html
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