AN exchange-traded fund (ETF) is relatively new to the investment world. It trades on the stock exchange like any other stock. The fund holds a set of assets which is designed to mimic an index in terms of composition. An index is a measurement of value of a particular section of the market.

For example, an ETF that tracks the S&P 500 index would contain some of the same stocks in companies on the S&P 500 list. The investment characteristics and management styles of ETFs are different from those of mutual funds.

Similar to a mutual fund, an ETF pools the assets of its investors together and uses professional management to meet the objective of its investors, whether it be income or capital appreciation. The vast majority of ETFs are designed to track an index so that their performance is close, but not an exact duplicate.

The difference between the ETF and the mutual fund may be attributed to the difference in composition, management fees, or handling dividends.

While most mutual funds are actively managed, ETFs are, generally, passively managed investments. In addition, ETFs can hold assets, such as stocks, commodities, or bonds, and trade close to their net asset value over the course of one trading day. ETFs offer an investment portfolio several benefits.

It first gives investors

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access to the global market, whereas mutual funds are generally only allowed to trade in the country it is registered. Exchange-traded funds have the same advantage as mutual funds when compared to buying individual stocks, which is diversification.

Diversification is key to any investment portfolio because it reduces your risk by spreading the portfolio amongst various assets so that they will not all be affected in the same way by market events. There’s still, of course, always some element of risk. However, you can generally minimise the risk of irrational market movements with diversification.

ETFs also give investors the opportunity to buy as little as just one share, and they are relatively inexpensive. Keeping in mind that with this one share they have just bought a composite of stocks/commodities/ bonds (whichever the particular ETF is tracking), it gives investors access to a diversified portfolio at a lower buying price point as opposed to buying individual securities.

ETFs cater to everyone from the lower-income and ambitious investor to the high-income investor. While a mutual fund investor will purchase the fund at the end of the trading day at the fund’s net asset value (NAV), an ETF trades throughout the trading day like a common stock, giving ETFs the benefit of more trading flexibility.

ETFs also generally have lower annual fees and are more costefficient. The passive nature of index investing, reduced marketing, and distribution and accounting expenses all contribute to the lower fees. However, trading ETFs typically incur brokerage fees as opposed to a mutual fund which generally charges a management fee and has no trade fee.

For investors who trade frequently, this would increase the cost of investing in ETFs. That said, with the low-cost brokerage fees, small or frequent purchases of ETFs are becoming more cost-efficient. Initially, exchange-traded funds were designed to track broad market stock indexes.

They have since been developed to track industrial sectors, investment styles, fixed income, global investments, commodities and currencies. They now have the capacity to duplicate just about any index available, making them very versatile. As previously stated, ETFs are designed to replicate the performance of an underlying index.

Investors are shown exactly what they are buying and are able to see which securities are included in the ETF. The fees associated with ETFs are also very clearly laid. There is a high level of transparency associated with exchange-traded funds.

Exchange-traded funds can add great value to any investor’s portfolio, from the experienced investor to the novice. It is a structured pool of assets which is managed by professionals: however, unlike mutual funds, which are tactically managed, ETFs are passively managed as they simply track an existing index and will, therefore, replicate that index’s performance without much active management.

They provide diversification at a lower buying price point which makes it easier for lower-income investors to start an investment portfolio, but also great for every investor by minimising the risks of loss.

ETFs are also generally a more costefficient investment option. Whether you’re new to investing or an expert, the benefits of ETFs will help secure your financial freedom. Renee Barnett is a marketing officer at Stocks and Securities Limited.