A comprehensive guide to ETFs: What they are and how they work in Singapore
Exchange-traded funds, or ETFs, have become very popular among investors in Singapore, as they offer the potential for higher returns and liquidity than traditional investments. ETFs are a security that tracks an index, such as the Straits Times Index or the MSCI Singapore index, and trades like a stock on an exchange. Understanding how ETFs work before investing in them is essential, as risks can be associated with this type of investment.
An ETF is a fund that contains many securities, such as stocks, bonds or currencies, tracked by an underlying index. When you buy into an ETF, you get exposure to all the components of the underlying index it tracks instead of having to purchase individual stocks. ETFs can diversify your investment portfolio, as they help spread risk and reduce volatility due to their broad exposure to different markets and sectors. They are also relatively low cost compared to other types of investments, as they are not actively managed like mutual funds, which means no fund manager is required to select the securities in the ETF.
When purchasing an ETF, you must understand its structure and how it works. The main components of an ETF include the underlying index, tracking error (the difference between the return of an index and the return of a fund that tracks it), fees, liquidity and taxation. The underlying index determines the performance of the ETF; for example, if the Straits Times Index is doing well, the ETF will also perform better. Tracking error measures how close a fund tracks its underlying index and is essential for investors who want to replicate the performance of an index exactly.
Fees are charged by the ETF provider, such as management fees and trading costs associated with buying or selling shares in an ETF. Liquidity refers to how easy it is to buy or sell shares in an ETF; this is important as investors may need access to their money at short notice if market conditions change suddenly. Finally, taxation is based on capital gains taxes applied when you sell your investments at a profit.
The types of ETFs available in Singapore
In Singapore, many ETFs are available to invest in that track different indices, sectors and asset classes, such as equities, bonds and commodities. For example, the Nikko AM Singapore STI ETF tracks the Straits Times Index and exposes investors to the 30 largest companies on the Singapore Stock Exchange. Similarly, The Lion-Phillip S-REIT ETF allows investors to access a portfolio of Real Estate Investment Trusts (REITs).
ETFs provide access to global markets and foreign currencies without opening a foreign trading account. One example is the ABF Singapore Bond Index ETF, which tracks the performance of Asian bonds denominated in US dollars. Investors can also buy ETFs that track the performance of different asset classes, such as commodities and gold.
What are the risks associated with investing in ETFs?
Investing in ETFs is not without its risks. As with any investment, there is the potential for losses if the underlying index falls. There is also a risk of currency fluctuations affecting returns when investing in ETFs that track global markets and foreign currencies. Furthermore, investors should be aware of the tracking error associated with ETFs, as this can lead to differences between the return of an index and the return of a fund that tracks it.
ETFs are also subject to market risk, where prices can fluctuate due to supply and demand factors, which means investors could potentially lose money if the price moves against them. Additionally, liquidity is another risk factor; some ETFs may need more buyers or sellers to enable easy trading at any given time, which could lead to difficulty in buying or selling shares.
Investors should also be aware of fees and taxes associated with ETFs. Most ETF providers charge a management fee that can impact overall returns; therefore, comparing fees across different providers is essential before investing in terms of taxation, capital gains taxes apply when selling investments at a profit, so investors should seek professional advice from brokers like Saxo Bank if they are unsure how this applies in their situation.
The bottom line
By understanding how exchange-traded funds work, investors can make more informed investment decisions and better manage their portfolios for higher returns. With a wide range of ETFs available in Singapore, investors can access global markets without incurring high costs or trading risks. Researching an ETF’s underlying index beforehand, along with its fees, liquidity and taxation, is crucial in determining whether it suits your investment needs.