This week, our Investment Manager Goncalo Machado sat down with Sterling Savvy to discuss all things exchange-traded funds (ETFs). His experience is extensive, working with ETFs for close to a decade within boutique investment firms and family offices.
Put simply, ETFs are a type of fund that makes it easy for anyone to get into investing. They’re low-cost and make diversification effortless for even the most novice investors – and, Goncalo works with ETFs daily in his role at InvestEngine.
Using Google search data, we’ve gathered the most asked questions about ETFs in the UK. And what better way to have them answered than by an industry expert?
Will Fenton, Founder of Sterling Savvy: Let’s start with the basics. Many of Sterling Savvy’s readers are new to investing. Maybe they’ve heard about stocks and shares, ISAs, and pensions, but an Exchange-Traded Fund (ETF), what’s that?
What is an ETF (Exchange-Traded Fund)?
Goncalo Machado: An ETF is a basket of individual securities traded as a single unit in an attempt to replicate the performance of an index. For example, traditionally, if you wanted to get the performance of the FTSE 100, you’d have to buy circa 100 stocks individually, which is inconvenient, time-consuming and expensive.
ETFs simplify this by allowing you to buy one unit in an FTSE 100 ETF, which encapsulates the index for a low cost.
Will: So that’s what they are, but our search data suggests that people want to know a bit about how they work and how they make money.
How does an ETF work? How do ETFs make money?
Goncalo: ETFs invest in a range of financial instruments that aim to replicate the performance of an index. This can be through investing in the underlying securities of the index, derivatives that replicate the performance of the index, or through other instruments.
They generate revenue for the ETF providers through a small management fee (typically ranging from 0.07% to 0.25%). However, unlike other investment methods, there are no entry and exit costs and they’re traded throughout the day.
Will: OK, great. Now that we know what ETFs are and how they work, how about their viability and effectiveness as investment products?
Are ETFs a good way to invest?
Goncalo: Put simply, they are the best way for an investor to gain diversification at a low cost, whether you’re new to investing or have been investing for a while. They are also an effective way for investors to gain exposure to securities which, due to their account size, would otherwise be very difficult to do so.
For example, the bond universe far exceeds that of stocks, and a number of bonds are illiquid. For an investor to gain exposure to thousands of bonds, they would require a sizable initial outlay and sophisticated trading facilities. Or, instead, they can simply buy one unit of a Global Bond ETF.
For the average investor, ETFs are the perfect vehicle for long-term wealth creation.
Will: Why?
Goncalo: Not only do ETFs offer instant diversification, but most ETFs also carry a very low fee which means investors keep more of their money.
The ETF investment universe is vast, with a near-unlimited combination of building blocks for investors to build a portfolio that suits their goals. This allows even novice investors to construct a diversified portfolio.
The breadth of ETFs available is vast – some track equities, bonds or commodities, while others dive into particular themes, bond durations and sectors. There are funds out there to satisfy the needs of most investors.
Will: At this point, the reader is probably trying to work out if ETFs are for them. So, what would you suggest they consider when deciding if ETFs are a suitable investment option?
Who are ETFs good for? Are ETFs good for beginners?
Goncalo: ETFs are great for all investors, thanks to their low cost and their approach to diversification – in most cases, it’s better to diversify across a range of businesses instead of putting your cash into one stock or share.
Then you have the huge range of ETFs that are available. On InvestEngine, you can access nearly 600, but also find ones that align with your interests and philosophies. We also have a great feature that gives you a breakdown of each ETF, from its sectors to its specific companies – you can also see the same breakdown of your whole portfolio.
Will: Great. Off the back of this, now is probably a good time to answer one of the most searched questions in the UK regarding ETFs…
How do I start investing in ETFs? Can I invest in ETFs on my own?
Goncalo: Absolutely – there’s a huge range of ETFs, which can seem daunting, but there’s a wealth of information online to help beginners learn about getting started with ETF investing.
Always make sure you know how much you can afford to invest, as every type of investing comes with a level of risk. If you’re not sure about choosing ETFs for yourself, my role at InvestEngine is to manage the ETF model portfolio service for clients, with a range of different risk levels, so you can leave it to us!
Will: Also, it only seems fitting to chat about InvestEngine. Tell us about the platform and what it does. Is it safe, regulated, good for beginners, and how much does it cost to use?
What is InvestEngine?
Goncalo: InvestEngine is an ETF specialist platform, based in the UK! We launched in 2019, and are dedicated to providing low-cost, simple-to-use investment options for consumers and businesses in the UK. Whether you want to invest in an ISA, General or Business account you can do this with our commission-free DIY accounts or if you’d like to leave it to our investment team we offer our Managed Accounts with a 0.25% annual fee.
Will: Amazing Goncalo. And tell us a bit about the company. Who founded it, why did they create it, and what does the future hold for InvestEngine?
What is InvestEngine’s vision for the UK?
Goncalo: We recently launched our report, ‘Building a nation of investors’, where we interviewed consumers in the UK and Germany, and there’s a huge disparity between education and investing styles. We want to ensure British investors have access to low-cost, straightforward investment opportunities to help support their future wealth.
Will: Sounds amazing. Everything so far has been positive, but there have to be some drawbacks to ETFs, right? And some things investors need to carefully consider.
What is the downside of ETFs?
Goncalo: I’ve worked with ETFs for nearly a decade, and honestly they are the perfect solution for the majority of investors on every level and the benefits outweigh any negatives.
Perhaps I would say that the variety on offer can be initially confusing for investors, which is why it can be overwhelming to get into ETF investing. For example, leveraged ETFs, short ETFs and commodity ETFs can perform in a slightly different way to what a beginner investor would expect – it’s always best to research what you’re looking to invest in!
Will: Interesting Goncalo.
How do they compare to, say, mutual funds, index funds, stocks and bonds?
Goncalo: Mutual funds usually carry much higher associated costs and are usually associated with active fund management, which is where the fund manager attempts to beat the market. Index funds are closer to ETFs, but can be traded throughout the day at an exchange and usually carry a lower expense ratio. Fractional trading is also possible with ETFs, allowing more investors to start their investing journey.
When it comes to single stocks, they come with all sorts of risk, from diversification and risk to liquidity and correlation within the portfolio. This is also true of bonds. However, buying into a bond ETF, for example, comes with instant diversification and exposure to sometimes 1,000s of individual bonds. Bonds, in general, are more liquid than stocks, which makes diversification difficult for an individual investor.
Will: Interesting Goncalo.
Let’s start to wrap things up with another one of the most searched questions on Google regarding ETFs.
Which is the best ETF? How do you choose which ETFs to invest in?
Goncalo: That’s a tricky question – there is a huge range on offer! Ultimately, most consumers are looking for equity exposure (which is reflected in what we see at InvestEngine). Within equity exposure, global equity funds are the most popular, probably because they’re diversified further than most geographical ETFs.
I think if you’re looking to find the ETF that’s right for you, look at the range of business areas you can invest in and find something that aligns with you. Check the past performance as, while it is not indicative of future performance, it’s really helpful in informing your decision. Finally, always make sure you know how much you can afford to invest.
Will: Great, it’s been a pleasure speaking to you today Goncalo, and sharing all your knowledge and expertise. I do have one more question for you…
What does the future hold for ETFs in the UK?
Goncalo: The UK always lags a little bit behind the American market for ETFs. One thing is that we’re starting to see the rise of active ETFs in the UK, which are ultimately systematic investment strategies, which adjust exposure to the underlying index based on a set of rules.
We also know that UK consumers need more education to support their confidence in investing, which is why we’re launching an Education Series. This will share the knowledge of a number of financial educators and help people get comfortable with the fundamentals of investing.
You can read Sterling Savvy’s full InvestEngine review by following the link.
Important information
Capital at risk. The value of your portfolio with InvestEngine can go down as well as up and you may get back less than you invest. ETF costs also apply.
This communication is provided for general information only and should not be construed as advice. If in doubt you may wish to consult a professional adviser for guidance.
Tax treatment depends on personal circumstances and is subject to change, and past performance is not a reliable indicator of future returns.