An exchange-traded fund (ETF) is a pooled investment vehicle that trades on a stock exchange and tracks an underlying asset, index, or basket of assets. ETFs are related to mutual funds in that they offer diversified exposure to a wide range of assets, but they trade like stocks on an exchange. It makes them more liquid and easier to trade than mutual funds.
Diversification
ETFs are pooled investments and can offer exposure to various asset classes, including stocks, bonds, commodities, and real estate. This diversification can help protect your portfolio from the volatility of any one asset class.
Liquidity
ETFs are more liquid because they trade on a stock exchange, meaning you can buy and sell ETFs anytime during the trading day at the current market price. On the other hand, mutual funds can only be traded once per day at the end of the trading day.
Low costs
ETFs typically cost less than mutual funds because ETFs are passive investments that track an underlying index or basket of assets. On the other hand, mutual funds are actively managed by a fund manager who incurs higher costs.
Tax efficiency
ETFs are more tax-efficient because they generate fewer capital gains. After all, ETFs are passively managed and only buy and sell assets when there is a change in the underlying index. On the other hand, mutual funds are actively managed and often buy and sell assets to take advantage of market opportunities.
Flexibility
ETFs offer more flexibility than mutual funds because you can trade them anytime during the trading day. You can also buy and sell ETFs in any quantity, unlike mutual funds, with minimum investment requirements.
Transparency
ETFs offer more transparency than mutual funds because you know what assets are held in the fund at all times. Mutual funds do not have to disclose their holdings daily, so you may not know what assets are held in the fund.
Access to global markets
ETFs offer exposure to global markets that may be difficult to access with mutual funds. For example, you can invest in an ETF that tracks the Chinese stock market without having to open a brokerage account in China.
Risks of trading ETFs in the UK
ETFs are subject to market risk
Like all investments, ETFs are subject to market risk. The value of your investment can fluctuate in response to changes in the underlying asset, index, or basket of assets.
ETFs are subject to tracking error
Tracking error is the balance between the return of an ETF and the return of its underlying asset, index, or basket of assets. Tracking errors can originate from several factors, including fees, expenses, and the method used to track the underlying assets.
ETFs are subject to counterparty risk
Counterparty risk is that the other party in a transaction may not fulfil their obligations. For example, if you buy an ETF that tracks a basket of assets, the ETF provider is the counterparty. The risk is that the ETF provider will not be able to pay you the return of the underlying assets.
ETFs are subject to liquidity risk
The liquidity risk is that you will not be able to sell your investment at a fair price. It can happen if there are not enough buyers in the market or the ETF provider decides to delist it.
ETFs are subject to currency risk
If you’re investing in an ETF that tracks a foreign asset, index, or basket of assets, you are exposed to currency risk. It will affect the value of your investment, causing it to fluctuate in response to changes in the exchange rate between the British pound and the foreign currency.
What do traders need to trade ETFs?
- You will need a brokerage account that offers you access to the London Stock Exchange.
- You will need to have enough money in your account to cover the cost of the ETF shares.
- You must understand the risks involved in trading ETFs.
- You will need to have a plan for how you will trade ETFs.
- It would be best to converse with a financial advisor to ensure that trading ETFs is appropriate for your investment goals.
You can trade ETFs with Saxo Bank, which is regulated in the UK and offers a variety of funds for you to choose from and invest in.