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What is an ETF (Exchange Traded Fund)?

You might have heard the active versus passive investment management debate, or you might not have done. You might not understand how this debate could impact your nest egg, maybe you don’t even care? Ultimately the active versus passive debate boils down to cost and return. And the reason this debate has grown in recent years is the increasing popularity of exchange traded funds, or ETFs.

What is an ETF?

An ETF is a passive investment instrument. Passive investing aims to maximise the returns over time by minimising the amount of buying and selling. Fees act as a drag on performance, every basis point you spend on fees has a negative impact on your returns.

An ETF is a passive fund that tracks an index, a specific commodity, or bond, or even an entire basket of assets. The great thing about ETFs is that they trade like a stock on the stock market; they experience price changes throughout the day as they are bought or sold. This means that ETFs typically have higher liquidity (you can sell them easily) and lower fees than many other instruments. This means that investors can have a flexible and efficient investment portfolio.

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How is an ETF created?

The ETF provider, usually a large financial institution with a high degree of buying power, can create the units of an ETF. They will buy the underlying assets that make up the index, in the same proportion as the index, and then sell this basket on the market as a fund.

Advantages of ETFs

When an investor owns an ETF they gain access to a range of assets within that index. This means they have a more diverse portfolio than buying a single stock because each index is built up of multiple assets. Investors are also able to gain access to markets at a fraction of the cost. ETFs have opened up the world of investing.

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