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Our Guide to ETF Investing for Beginners

Investing in ETFs combines the flexibility of trading individual stocks with the built-in diversification and low costs of mutual funds. They don’t require a great deal of expertise to understand or evaluate, and they can allow novice investors to potentially beat the market’s performance. If you’re new to ETF investing, here’s a rundown of what you should know before you get started.

What is an ETF?

ETF stands for “Exchange-Traded Fund.” ETFs allows you to trade shares like an individual stock, but own a large group of stocks like a mutual fund – particularly an index fund. ETFs are a relatively new invention. The first one was launched in the US in 1993, and they have only been available to HK investors since 1999.

Tracker Fund of Hong Kong (2800.HK) is the first ETF to hit Asia outside of Japan. It was created by the Hong Kong government-led massive intervention in the local share market in 1998, at the height of the Asian financial crisis. The government launched the fund to sell shares.

The fund very efficiently does its job of tracking the Hang Seng Index – it has one of the lowest tracking errors seen among Hong Kong ETFs. The fund physically owns big chunks of the stocks underlying the Hang Seng index, which means it does not have to rely on derivatives or tricks to replicate the index’s performance, or complications like dividends payments. It’s fairly simple and transparent – and it’s cheap: Expenses are just 0.15% annually.

How do ETFs work?

You can buy and sell ETFs the same way you would any company’s shares, through any brokerage account, at any time during normal trading hours.  ETFs are not shares of a company, but units of a fund that holds a portfolio designed to closely track the performance of a chosen market index. ETFs offer new ways to get cost-effective exposure to the markets you want. Like traditional mutual fund owners, ETF investors own a pool of stocks.

What are ETFs’ advantages over stocks?

Less Risk: Enjoy the convenience of an ETF, which already contains a preselected collection of stocks. If a single stock is performing poorly, there’s a good chance that another is performing well, which helps minimize your losses.

Less Work: The Tracker Fund contains 50 different stocks of the Hang Seng Index. It would take weeks for an individual investor to study each of those names. That’s one of the advantages of ETF investing: Investors can save the overwhelming time of initial and ongoing due diligence.

Mutual funds vs. ETFs: Which are better? 

When you’re choosing between mutual funds and ETFs, here are a few key pros and cons that can help:   

ETFs offer more trading flexibility: ETFs are traded like stocks. They’re priced based on what investors think the market value is, and you can buy and sell shares throughout the day. Mutual funds, however, can only be purchased or sold at the end of the trading day after the market closes, and their price is based on Net Asset Value (NAV) — the value of fund assets minus liabilities, divided by the number of shares.

ETFs provide more transparency: ETFs typically disclose holdings daily. Actively managed mutual funds typically disclose their holdings on a quarterly or semiannual basis.

ETFs often have lower fees and expenses: ETF expense ratios are typically lower than mutual fund fees. In 2016, the average expense ratio of index ETFs was just 0.23%, compared with a 0.82% average expense ratio of actively managed mutual funds and a 0.27% expense ratio for index equity mutual funds, according to the Investment Company Institute. Many mutual funds include a variety of fees in their expense ratio, including fees to cover marketing and distribution costs.

ETFs often require lower minimum investments: Although there are some options for mutual funds that don’t require you to invest a lot of money at once, many mutual funds have high initial investment requirements. This makes it a challenge to get started investing in a mutual fund if you don’t have a lot of money saved. ETFs allow you to buy as little as a single share in the US, which means that you don’t need a fortune to get in the market.

Mutual funds allow you to trade without paying commission: Because ETFs are traded like stocks, you typically must pay a commission to buy and sell them. There are some commission-free ETFs available, but they may have higher expense ratios to recoup money lost from being commission-free. Mutual funds, by contrast, do not charge commission, although front-end or back-end loads paid when buying or selling can work similarly to a commission. There are, however, many no-load mutual funds that can be bought and sold with no broker commissions. Investors who plan frequent transactions, such as investors using dollar-cost averaging, may be better off with a mutual fund that does not charge a broker commission for each trade.

Mutual funds are more likely to be actively managed: Most ETFs are index funds, which track market indexes. While there are some actively managed ETFs, these tend to have higher prices. While some mutual funds are passive index funds, there are far more actively managed mutual funds than actively managed ETFs. With an actively managed mutual fund, a fund manager makes choices about how to allocate fund assets as opposed to assets being purchased simply to track an index. Active management can be a good thing if the fund manager is talented and is able to outperform the market. However, not all fund managers are good ones — and you’ll still likely pay higher costs for a poorly managed mutual fund than for passively managed ETFs.

A final thought

Both ETFs and mutual funds provide an easy way to invest in stocks and build a diversified investment portfolio. By doing a little research to select either a good ETF or mutual fund, you’ll usually end up better off over time than if you’d simply left your money in cash or bought real estate — so don’t be afraid to get into the market with a fund that is right for you.