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What is an ETF?

This is a question that people often ask.  Firstly don’t be confused by the very similar term EFT; which is an Electronic Funds Transfer and has nothing to do with trading and is a transfer of cash from one bank to another.

 

Let’s start by defining an ETF, an ETF is an Exchange Traded Fund and is most often a share that tracks a well-known index like our JSE TOP40 (which in turn tracks the performance of the 40 largest shares on our market.)

Why do we buy them? Well instead of going out and buying all 40 shares that make up this index (and having to do 40 trades which can be very expensive, time consuming and a general hassle) we rather go out and buy one share (being the ETF) that tracks the performance of the index for us. Much simpler and cheaper!

 

There are numerous advantages to ETFs and without getting too technical I will go through some of them. Firstly they give you instant diversification – put simply by being exposed to all the shares in the index you are not exposed to the risk of just one share (that could go bust) but rather a basket of shares, this diversification reduces the overall risk of your investment. Another advantage is in terms of costs; ETFs which are often compared to Unit Trusts are cheaper and have lower TERs (Total Expense Ratio’s). ETFs are also cheaper than trading the underlying shares directly as they don’t attract STT (securities transfer tax) so this is a 0.25% saving when compared to buying shares directly.

A major attraction for first time ETF investors is that they are allowed in your Tax Free Investment Accounts (TFIA), shares are currently not. This means that they are amongst the best building blocks for anyone looking to start up a Tax Free portfolio.

 

ETFs are also very easy to trade and you trade them directly through your Online Share Trading portfolio in the same manner that you trade other shares, in essence you can trade into an out of them on a daily basis should you wish.

The world of ETFs is incredibly exciting and is growing rapidly in South Africa, they come in all shapes and sizes and now cover our local market, international markets, bonds, currencies, commodities and the list continues to grow.

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