When getting into stock trading; you will often hear about ETFs, but what exactly is an ETF and how does it work? Is it even something you should buy?
What is an ETF?
An ETF is a basket of securities, shares of which are sold on an exchange. They combine features and potential benefits of stocks, mutual funds, or bonds. Like individual stocks, ETF shares are traded throughout the day at prices that change based on supply and demand. Like mutual fund shares, ETF shares represent partial ownership of a portfolio that’s assembled by professional managers.
How does it work?
An ETF is basically a basket that contains a bit of everything. Imagine a fruit basket that contains different types of fruits; ETFs work in a similar way. When you buy an ETF, you are buying a basket of shares.
Why do this instead of buying individual stocks? ETFs are much safer than buying individual stocks, especially ones that mimic the market. Over 96% of traders don’t outperform market mimicking ETFs in the long run. Let’s say you buy shares from Sasol, then those shares go down in value for a period of 12 years; that would be a huge loss on your side.
A much better thing to do would be buying a basket (ETF), that contains companies like Sasol, ABSA, FirstRand, Standard Bank, Old Mutual and all the major companies in South Africa. That way; even if Sasol shares go down; you won’t get hurt that much because other companies in the ETF might be performing well.
Types of ETFs
Diversified passive ETFs
These ETFs mainly mirror the stock market, using benchmarks such as the S&P 500, Dow Jones or the top 40 in South Africa. Satrix is one popular ETF that mirrors the South African stock market by using the top 40 best performing companies.
Niche focused ETFS
These are ETFs that are focused on a particular niche, like beverages, food, auto, and even cannabis. You use these ETFs when you want to invest in a particular sector, you can buy a basket that only contains banks or beverage companies and so on.
You can also buy an ETF that contains crypto coins; instead of buying the individual coins. In this way; you are investing in the future of crypto currency and not just a specific coin.
Conclusion
This was an overview of how ETFs work in South Africa. Do you have any thoughts or questions? Comment below.
