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ETFs


Author: Thomas F. Pfeifle

What are Exchange Traded Funds (ETFs)

Exchange Traded Funds, also known as ETFs, are investment funds traded on the stock exchange. They bundle a large number of shares and thus diversify the portfolio very widely. ETFs often bundle companies from a common industry, such as the technology sector or the automotive industry, but can also map countries and their economies. Thus, one can invest in purely German ETFs or also in ETFs from emerging markets or developing countries. 

ETFs are divided into passive and active management. With passively managed ETFs, only the index of an industry or country is represented. The fees are much lower, but it is not possible to react to economic changes and adjust the ETF. Actively managed ETFs, on the other hand, are based on a genuine active management by the Bank. A fund manager buys and sells shares and adapts the ETF to the economic situation and its fluctuations. This means that a financial expert can react to changes at any time, but the fees are correspondingly higher. Actively managed funds are generally subject to higher risk, as the fund manager alone decides and adjusts the portfolio to the best of his knowledge. Even fund managers are only humans and cannot predict the future and are therefore not always 100 percent correct. With passive ETFs the risk is much lower, but so is the profit, as the ETF remains constant and cannot be adjusted to the current economic position.

Like other stocks, ETFs can be traded on the stock exchange at any time. 
Well-known examples of ETFs are the S&P 500, which includes the shares of the 500 largest US stock exchange-dated companies, or the MSCI World, which includes over 1600 shares from 23 different countries. 


Pros and Cons of ETFs


Pros

Compared to traditional funds, ETFs have very low ongoing costs. The costs depend on the individual ETF, but mostly lie beneath 1% and lower, which makes them very cheap and affordable. 

Another advantage lies in the transparency of ETFs. In contrast to traditional funds, the transparency enables the investor, to see what lies behind the ETF and which shares the ETF contains. You can always see what you invest in and can make up your decision which ETF fits best to your personal interests.

Due to the huge number of shares in the Exchange Traded Fund, a widespread diversification is guaranteed. The combination of different shares spreads the risk of under performance tremendously and increases the chance of higher profit. The investment of smaller amounts is also possible through savings plans.

 

Cons

As Exchange Traded Funds track market indices, it is impossible to minimize the effect of market downturns, so it cannot be reacted to changing economic situations and the ETF cannot be adapted to it. 

ETFs often focus on a specific economic sector, like healthcare or the automotive industry. This narrow focus causes a higher risk in case the sector under-performs. So, one may consider combining ETFs with global ETFs, to guarantee more sector diversification and to protect your portfolio against market sector down-performances. A global ETF does not focus on a specific region or sector and tracks the overall performance of the world market, which significantly lowers the risk and diversifies the portfolio. 

Where can I invest in ETFs? 

The investment in ETFs requires a depot from a bank or from another provider of your choice. If you already have a depot, you can buy and sell ETFs with ease in some simple clicks. 

If you do not have a depot yet, we can recommend the Free App Trade Republic, which offers a multitude of different ETFs and even provides saving plans for your monthly investment strategies, which supports you to reach your financial goals!

Trade Republic link rein