Exchange Traded Funds and Lego bricks

Lego has captured the imagination of our children for generations. Its bricks can be used to build just about anything.

Exchange Traded Funds (ETFs) are a little like lego bricks because of their simplicity and the way they can be combined to build a diversified investment portfolio.

Exchange Traded Funds are a little like lego bricks in that they can be combined to build almost any diversified investment portfolio.Credit:iStock

What are ETFs?

ETFs are listed on a stock exchange and can be bought and sold like ordinary shares. Their underlying holdings are typically a basket of shares or bonds which usually track a particular index.

For example, an ETF which tracks the performance of the top 200 companies listed on the Australian Securities Exchange has the code STW.

While this ETF mirrors the performance of 200 ASX-listed shares, you need only buy one investment. However, you receive the flow through of dividends and capital growth of all the underlying shares.

Booming investments

Like Lego in the 20th century, ETFs in Australia are growing at a phenomenal rate, reaching $50 billion of assets under management, according to the latest figures from the ASX.

Since 2014, they have grown by an astounding 30 per cent a year. However, we still have a long way to go compared to the US, where they account for more than $3.4 trillion of assets.

And the reasons for their dramatic increase in popularity? They are great lego pieces.

There is strong theory which supports the fact that asset allocation is a far greater determinant of investment returns than stock selection. That is, the percentage of funds you hold in the asset classes of shares, fixed interest and property, will likely have a far greater impact on your returns than your own stock picks.

ETFs are a great way to combine asset class returns. There are more than 180 ETFs listed on the ASX, tracking sectors such as large or small companies, international markets, property trusts or fixed interest.

Low cost

ETFs which track an index are low cost. For example, the BetaShares Australia 200 ETF (ASX code A200) has an expense ratio of just 0.07 per cent, or $70 for each $100,000 invested. ETFs which track smaller, more specialised indexes may have expense ratios a little higher. For example, the Van Eck Vectors Small Companies Masters ETF (ASX code:MVS) has an expense ratio of 0.49 per cent.

Easy to trade

Because you can buy and sell them like a share, you can keep transaction costs even lower by using an on-line broker or an investment platform through a financial planner.

Reuben Zelwer is principal and certified financial planner at Adapt Wealth Management.

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