Lesson 1: The concept and advantages of ETFs

Hi, everyone!  😄 Welcome to this session of the Tiger Academy “ETFs for Beginners”

In this course, I’m going to introduce you to the popular “stars” of the investment world – Exchange-Traded Funds or, as they are commonly known, ETFs. This ETF course has seven lessons.

They are: concept and advantages of ETFs, classification of ETFs, eight steps to choose the right ETF for you, trading strategy for ETFs, ETF investment and strategy, risks associated with investing in ETFs and how to trade ETFs on the Tiger Trade app.

Through these seven lessons, I will teach you what ETFs are and how to trade them.

In the US, ETFs have become a widely known and commonly traded asset class. In fact, at the end of 2021, there were 2,900 exchange-traded ETFs!

Over the past decade, the total market cap of ETFs traded in the US has risen significantly from approximately $1.4 trillion to $6.2 trillion.(Data source: Bloomberg; The statistical period is up to 2021) ETFs have become some of the most popular financial products among investors due to their transactional convenience, low handling fees, and wide variety.

In this lesson, I'll start by giving you a brief introduction to the concept and benefits of ETFs.

1. What is an ETF?

ETF means “exchange-traded fund.” To help you understand how the ETF works, I'll break it down into its three parts:

Firstly: Trading

ETFs are funds that can be bought and sold like stocks. For example, you can trade the Nasdaq 100ETF (QQQ) directly on the Tiger Trade app in both "pre-market" and "intraday trading" modes.

Secondly: Index

ETFs are funds that track not only well-known securities indexes such as the S&P 500 Index, the Nasdaq Index, and the Dow Jones Index, but also many other indexes that aren't as well-known. Nearly all indexes have a corresponding ETF.

Finally, there is the “Fund” aspect

ETFs are basically a type of mutual fund that invests in stocks. Each ETF is issued and run by a fund company, and each one has a fund manager in charge of it.

Moreover, ETF funds are open-end funds, which means they can be bought or sold at any time. By understanding the above three points, you will understand what an ETF is.

But many investors will ask, “There are so many excellent financial products in the market, why should I invest in an ETF?”

Let's start with a story about investment guru Warren Buffett~

2. Why does Buffett recommend that investors choose ETF funds?

There is a story that has circulated in US investment circles that, in his will, Buffett advises his wife, who is not good at investing, “If you want to invest, just buy an S&P 500 index fund.”

This advice may seem too simple, but it works very well. In fact, it works better than many "fancy" hedge funds.

In 2007, Buffett made a bet with hedge fund manager Ted Siders that hedge funds could not beat the performance of S&P 500 index funds.

Figure 1. Source: Quantitative Research (This data is for information only. Past perfomance is no guarantee of future results.)

Figure 2. Source: Quantitative Research （This data is for information only. Past perfomance is no guarantee of future results.）

Ten years later, as Figure 1 shows, the five hedge funds owned by Ted Sides were indeed underperforming the S&P 500 and Buffett won the bet. But Buffet’s own Berkshire funds also failed to outperform the S&P 500 over the same period of time! (Figure 2);

Over the past decade, the S&P 500 has gained more than 12% annually, while Berkshire has appreciated less than 11% per year.

That doesn't mean that all actively managed funds underperform index-based ETFs. But for most investors, passive ETFs are at least a good option because they give an average return on an asset class they like.

3.Two advantages of investing in ETFs

In addition to gaining the favor of investment guru Buffett, investing in ETFs has the following two advantages: Save trouble and saving money.

1.Save trouble

A. No more stock picking and spread risk worries

For most investors, a key point that presents difficulty is stock selection. If you don't have enough time and energy to research stocks, an ETF fund is the way to go.

Because ETFs represent a basket of stocks, if one of those companies announces poor earnings results, it will have limited impact on the ETF as a whole. So, for new investors, buying ETFs not only avoids the trouble of picking stocks, but also spreads investment risk.

B. Transparent information and stable style

Compared with ordinary open-end funds, ETFs hold a great advantage in information disclosure. The holdings and weighting of ETFs are disclosed on a daily basis. Investors can view them on the website of the ETF issuer and information transparency is very high as well.

Investors can find not only the names and proportions of constituent stocks as of the previous trading day, but they can also get other information such as the estimated cash value of the fund that each of the stocks in the ETF basket represents. Regarding trading hours, ETFs update their net asset value (NAV) every few seconds, so, just like stocks, we can keep track of their price changes.

Compared to funds that only announce NAV at the close of the day, ETF transactions are much more transparent and convenience. This makes investments much more efficient and makes the whole process less stressful.

C. Flexible trading mechanism and efficient use of funds

In terms of buying and selling, ETFs are also more flexible and efficient!

For subscriptions and redemptions, the net value of open-end funds is calculated after the close of each trading day.

But ETFs can be bought and sold at market prices at any time during trading hours, and do not need to wait for the net value to be settled at the close.

In the event that the stock market falls sharply on a given day, an ETF can be sold during the trading session, which not only allows for more efficient trading, but also makes it possible to proactively control losses that might be caused by such a fall.

When you want to redeem an open-end fund, it usually takes 7–10 business days for the money to settle in your account. During this time, you can't do any other transactions.

When you sell an ETF, you can do another transaction right away, so you don't have to wait as long for the money to become available in your account.

2. Save money

The second advantage of ETFs is saving money.

In the US, the average annual management fee for equity funds is 1.42%, compared to just 0.53% for equity ETFs. When it comes to fees to buy and sell ETFs, they are much lower than those for regular open-end funds.

And don't underestimate management costs, which can add up to a lot of money over time!

If your principal is $100,000 and you trade five times a year on average, the cost of each transaction, including subscription and redemption fees, is about 2% for ordinary open-end funds and 0.8% for ETFs.

Assuming that the all of your money is placed into a fund or ETF at one time, the single transaction cost of an open-ended fund is $2,000, and the total cost for a year is $10,000. The ETF costs $800 for a single transaction, and the total cost over the year is $4,000.

In this way, the cost of trading ETFs can save you half that of ordinary open-ended funds. If you trade more frequently, ETFs can save a lot of money!

Well, that wraps up our class for today. Let's summarize:

In this lesson, we learned what an ETF is and that, according to Warren Buffett, the long-term return on ETFs exceeds that of most hedge funds. Finally, there are many advantages of ETF funds that can save you bother and money while allowing you to invest more efficiently.

In the next lesson, I’ll give you a deeper understanding of the ETF family and introduce you to different classifications of ETFs so that you’ll be able to identify which are actively managed ETFs and which are index ETFs!

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see you next time~

Disclaimer: The information herein was prepared for educational purposes, and does not constitute an offer, recommendation or solicitation, nor does it constitute any prediction of likely future stock performance. In preparing this information, we did not take into account the investment objectives, financial situation or particular needs of any person or affiliated companies. Before making an investment decision, you should speak to a financial adviser to consider whether this information is appropriate to your needs, objectives and circumstances. Tiger Brokers assumes no fiduciary responsibility or liability for any consequences financial or otherwise arising from trading in securities if opinions and information in this document may be relied upon.This advertisement has not been reviewed by the Monetary Authority of Singapore.