Investing in Funds & ETFs - Tips for Successful Investing

Investing in funds or ETFs (Exchange-Traded Funds) offers many opportunities and has particular advantages compared to individual stocks. These forms of investment are suitable for broad risk diversification and diversification, especially for smaller assets as well. It is very easy to cover a wide variety of asset classes such as "regular" company stocks, bonds, real estate or commodity prices. Here you will find useful information and tips on how you can meaningfully expand your portfolio with ETFs and funds.

 

What are ETFs? Basics and characteristics of ETFs

• With ETFs you can build wealth with stocks over the long term.
• ETFs replicate stock lists. On one hand, these can be well-known indices such as the DAX, S&P 500 or the global equity index MSCI World. In this case, a fund company uses investors' money to purchase all the securities contained in the index. On the other hand, there are also ETFs for all kinds of other stock groups, for example selected by specific countries/regions, by specific industry sectors, by economic factors (e.g. dividend aristocrats), by environmental or sustainability criteria, and much more.
• There are also numerous alternative ETFs that focus not on stocks, but for example on commodities, metals, real estate, bonds, short positions, speculative instruments or other investment forms.
• There are distributing ETFs that regularly pay dividends to you, as well as accumulating ETFs, in which dividends are automatically reinvested. If you want to generate passive income, distributing ETFs are well suited. If, on the other hand, you want to save for the future and build wealth over the long term, accumulating ETFs are probably better suited.
  More details and tips on the difference between distributing ETFs vs. accumulating ETFs have been explained for you in a separate overview.

 

Different types of ETFs

• Physical ETF - With a physical ETF, also known as a physically replicating ETF, all securities (stocks, bonds) are purchased according to their weighting in the index. This gives you as an investor maximum transparency, as you always know exactly which securities your money is currently invested in. When an ETF achieves 100% replication, it is also referred to as full replication. If the replication is slightly below 100%, this is referred to as minor deviations, known as the tracking error.
• Physical ETF with optimized sampling - With this type of ETF, not all stocks in the index are actually purchased, but only an optimized selection (partial replication). This can mean both advantages and disadvantages in terms of returns and risk minimization. A close look at the ETF's fact sheet is therefore always recommended. Fees are often lower with partial replication. Depending on your investment style, it may therefore be worthwhile to accept these small deviations from the index and save on fees.
• Synthetic ETF (swap) - Another way an ETF can replicate an index is through synthetic, or indirect, replication via a swap transaction.
  Such an ETF is based on a contract with a financial institution, i.e. a large bank, also called a counterparty. This financial institution commits to delivering to the ETF the exact return of the replicated index, i.e. for example the performance of the included stocks.
  • Since the swap ETF does not actually hold the stocks of its replicated index, but instead combines, depending on its investment policy, for example an investment in an alternative basket of stocks with the bank's swap contract, a so-called counterparty risk arises. In the event of the bank's insolvency, the ETF is left with outstanding claims from the swap contract. Since the swap portion is not part of the special assets, there is a risk for you that part of your invested money could be lost.
  • On the other hand, synthetic ETFs offer you a cost-effective alternative to invest in additional markets such as commodities, real estate or currency transactions, so that even as a private investor with a small portfolio you can cover special asset classes or niche products.
  • Furthermore, swap ETFs often offer you more cost-effective alternatives and sometimes better index replication than physical ETFs (smaller tracking error).

 

What are the advantages of ETFs?

• In short: Simple, cost-effective, transparent and flexible.
• Low costs: The acquisition and ongoing costs for ETFs are significantly lower than for actively managed investment funds.
  • Typically, the costs for ETFs are between 0 and 0.8 percent of the fund's assets.
  • For actively managed funds, on the other hand, they are often between 1.5 and 2 percent.
• Diversification – By purchasing an ETF, even as a private investor you can invest in entire investment markets quite easily and conveniently. 
  ETFs therefore allow you to build a very broadly diversified portfolio with thousands of securities from a wide variety of asset classes. This means a versatile asset allocation with less risk compared to investing in just a few individual securities.
• Simple administration. You do not have to manage a large number of stocks yourself. Topics such as taxation, use of dividends or rebalancing are handled on your behalf. 
• High security: ETFs are special assets. This means your invested money is kept separate from the ETF provider's operating assets and in the event of the ETF provider's insolvency, it is not part of the bankruptcy estate.
• Liquid market available: tradeable on the stock exchange at any time.

 

What are the disadvantages of ETFs?

• Certain ETFs can be very risky, in particular leveraged ETFs, short ETFs and other speculative ETFs should be used very consciously and you should be aware of the risks.
• There is now a huge variety of different ETFs, which can make it difficult to choose the right one ("too much choice can be overwhelming"). Before purchasing, you should therefore carefully examine and understand how your selected products work in order to be able to assess them correctly in all market situations.

 

 

Sources and interesting links

1. finanztip.de - Index funds (ETFs) - Investing in stocks simply and affordably: with index funds
2. verbraucherzentrale.de - What are the advantages of ETFs?
3. justetf.com - Advantages of investing with ETFs
4. scalable.capital - Physical vs synthetic ETFs: Everything you need to know
5. justetf.com - Swap ETFs: Synthetic replication of ETFs
6. extraetf.com - What is a swap ETF?

 

Do you also trade ETFs? Do you have further tips and suggestions about ETFs or specific funds? What are your experiences with building wealth? Feel free to leave a comment.

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