Investing in Exchange Traded Funds (ETFs). What are ETFs, pros and cons? Should you invest in ETFs in the US, globally, and/or in Malaysia?
What are Exchange Traded Funds (ETFs)?
ETFs are listed on the stock exchange. With an ETF, you buy a number of stocks/bonds/other investments which represent an index (aka index tracker)
An Authorized Participant (AP) or Market Maker creates and redeem ETF units
- To create shares of an ETF, the AP will purchase all the securities that make up the ETF in proportion to the overall portfolio. This “basket” of securities is then exchanged with the ETF issuer for to create units of the ETF.
- Likewise in reverse, to redeem shares on an ETF, the AP will accumulate a number of ETF units in exchange of a “basket” of securities of equivalent value.
ETF Pros & Cons
- Diversification with a single purchase including asset diversification, and possibly regional/international diversification.
- Trading of ETFs anytime and immediately (as long as there is a willing buyer and seller) when the market is available for trading.
- Lower buying/annual fees compared to mutual funds/unit trusts.
- ETFs may pay dividends which are generally tax-free (in countries that have investment income taxes) until you sell.
“After I die, I would put my money into a super-simple, ultra-low-cost, index fund which tracks the 500 biggest companies in America — otherwise known as the S&P 500. I believe the long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions, or individuals — who employ high-fee managers” ~Warren Buffett
- ETFs although diversified can be volatile especially if the ETF focuses on a particular sector.
- Although lower fees (in Malaysia) than Unit Trusts, you still incur brokerage and other fees which can add up especially if you make many transactions.
- You may face difficulties trading in ETFs that are not heavily traded (re: low volume/liquidity) with not many buyers and sellers.
- Overseas ETFs may still be subject to taxes (i.e. US ETFs have a 30% withholding tax).
How to Buy an ETF in Malaysia
You incur costs like buying and selling stocks when buying an ETF, including brokerage commission, stamp duty and clearing fees.
Like shares, ETFs are traded in minimum lots of 100 units in Bursa Malaysia and as low as 1 unit in international markets.
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