Home » Magazine » What ETF Means, What It Is, What It Does, And More
- Karolina Decker
- July 12, 2019
- July 26, 2023
During the past couple of years, ETFs have become an interesting constant among private investment. But often, it is not quite clear, what ETF means, what it is, how ETF funds work, and why they’ve become so largely popular. This article is about to change the understanding of ETFs for you.
What Are ETFs? A Definition.
Let’s start with the basics: what ETF means. ETF is an abbreviation, an acronym, to be precise, deriving from the term “exchange traded funds”. They are securities traded at the stock markets.
Originally, the name ETF was used for actively and passively managed security funds alike. But meanwhile, the ETF definition refers exclusively to passive funds. That means, there is no fund manager „in the background“, re-collocating the funds according to the index development and, thus, determines their value. Which might probably lead you to wonder how ETF funds work, if they’re not managed. Well, instead of someone actively reallocating them, passive funds, or ETFs, passively reproduce the development of a selected stock exchange index.
As a private investor, you benefit from how ETF funds work. Especially from the so-called cost average effect and especially in the long run. Said cost average effect comes along with the definition of ETF, in particular, if you’ve chosen an accumulation plan.
If you deposit a steady monthly savings rate into your ETF accumulation plan or plans for several years, you receive more economic funds shares, despite possible market fluctuations. Due to their passive characteristic, ETFs always compensate index peaks — which on the one hand add value to your acquired shares and on the other hand make shares that you will purchase more expensive — and losses — during which the shares you already own are less valuable, but the shares you will purchase cost less, too.
This leads to yet another curiosity about ETFs. Many might wonder whether ETFs can collapse. Well, pretty much not. Of course, your saved money might lose value due to inflation and index crashes. But usually, an ETF savings plan earmarks that during low-value periods, you automatically acquire more shares for the same amount of money. This compensates for general depreciation. And as soon as the index rises again, so does the entire value of you accumulation plan. On average, hence, you will always have made a profit, by the time your savings plan’s term ends.
Want to know more on how ETF funds work and which possibilities investing in them holds? Then don’t hesitate and contact the FinMarie team to arrange an individual assessment appointment.
These Characteristics Determine What ETF Means
By now, hopefully, we’ve provided the necessary information that let you know, what ETF means, how ETF funds work, and what they are: passive investment funds that are traded on the stock exchange and reproduce an index of your choice, such like the Dow Jones or the MSCI World. We will get to more details on this below, but let’s first have a look on some more ETF characteristics, so what ETF means can sink in and really stick to your mind. (Remember, FinMarie is about financial literacy among women, too.)
This is how exchange traded funds differ from other financial products:
- Due to their passive index replication, ETFs are less volatile then, for instance, stock funds are. This means, they are subject to fewer loss risks. And that is what makes them so interesting for private investors.
- ETFs are more flexible than many other investment types. This flexibility shows at several points. You can put them together yourself according to your choice; handy, if you think about, maybe investing in sustainable funds only. Above all, however, you can adapt your ETF savings plan to your current living conditions at all times. You can pause your deposit transactions or adjust your monthly savings rates so that they match your economic possibilities — this is possible, because ETFs are traded on the stock market, and, hence, can be bought and sold fast.
- Also, ETFs are transparent. One of the 3 golden rules of investment says to create a portfolio as diverse as possible. With ETFs, not only do you know exactly where you’re investing, but you can also retrace their value on a daily basis — if you want to, that is. A glance at the benchmark is enough to know which securities your ETF contains and how their development is.
- As opposed to actively managed funds, ETFs are relatively economic. Since there is no management required, you can save fees and administration expenses, if you invest in ETFs.
If you plan to invest your money over the long haul and, in addition to that, want to participate in the value development of different indices in an immediate and economic manner, while still have your investment flexibly available at any time, ETFs might be the right choice for you. No matter, whether you want to invest once or on a regular basis.
How ETF Funds Work
Hopefully, you’ve digested what ETF means by now. Because at this point, we’ll look into how ETF funds work a little closer. ETFs automatically invest in the same enterprises as the underlying index. Take a glance at the following example to better understand, how this is important for you and why this type of investment might pay off for you:
ETF: Where To Start
Generally, an ETF can be drawn up for any index, no matter whether we’re talking stocks, bonds or resources. But let’s just say, you invest your money in an ETF that replicates the DAX, i.e. the German Stock Index. This stock index is stipulated by the 30 largest German enterprises. So, you’re proportionally investing in the value of all these listed companies; your investment is divided according to the respective companies’ index weighting.
Assume that company A has a 10 % DAX index weighting and company B a 20 % weighting. This means, your ETF invests 10 % of your asset in company A and 20 % in company B.
When it comes to ETF investment, you basically have two ways to choose from. Either you go for a one-time capital contribution or you pick a savings plan that you maintain on a regular basis.
FinMarie is happy to help you in a personal conversation to find out more about investing in an ETF: where to start, what to do, which way to go, what the benefits and disadvantages are, and whether this type of investments could possibly suit you. A first assessment with our experts is free:
BY THE WAY: If your employer grants you capital forming benefits, you can have them contribute these to your ETFs.
What Kind Of ETFs Are There?
In Germania, there are more than 1,200 ETFs listet. For private investors, ETFs are a very promising tool, if they want to globally invest in a widely diversified manner. There are various categories, according to which ETFs can be composed:
- asset classes (e.g. stocks, bonds, resources)
- regions (e.g. Germany, Europe, euro zone, worldwide)
- strategies (e.g. sustainability, mega trends, technology)
- markets (e.g. developed countries, emerging countries)
ETFs are gaining a wide popularity. This shows not only in the increasing number of ETFs per se, but also in their respective volumes. Researchers at the renowned Steinbeis-Hochschule at Berlin are foreseeing a very positive development of ETFs in Germany:
- The development over the recent years shows that transparency plays a larger and larger role for private investors.
- The popularity of ETFs continues to increase which results, amongst others, in a growing demand and, hence, also supply. This leads to a larger range of ETFs for investors to choose from.
- ETFs are suitable for capital accumulation and retirement savings plans alike.
- Umbrella funds and standardized asset managements are liable to intensify their ETF investments.
At FinMarie we keep you informed on investment possibilities in general and ETFs in particular. Subscribe to our newsletter and receive every post we publish by mail!
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I'm an enthusiast with a deep understanding of Exchange Traded Funds (ETFs), and I'm here to provide you with comprehensive insights into the concepts discussed in the article "What ETF Means, What It Is, What It Does, And More" by Karolina Decker.
Introduction to ETFs: ETF stands for "Exchange Traded Funds," and they are securities traded on stock markets. Originally, the term was used for both actively and passively managed security funds, but it now exclusively refers to passive funds. Unlike actively managed funds, ETFs passively reproduce the development of a selected stock exchange index.
How ETF Funds Work: ETF funds work by automatically investing in the same enterprises as the underlying index they replicate. For example, if you invest in an ETF that tracks the German Stock Index (DAX), your investment is divided according to the respective companies' index weighting. This passive approach allows private investors to benefit from the cost average effect, where steady monthly contributions accumulate more economic fund shares over time, compensating for market fluctuations.
Characteristics of ETFs:
- Less Volatility: ETFs are less volatile than stock funds due to their passive index replication, reducing loss risks.
- Flexibility: ETFs offer flexibility in customization. Investors can put together their ETFs according to their preferences and adjust savings plans based on current living conditions.
- Transparency: ETFs are transparent, allowing investors to know exactly where they are investing and retrace their value on a daily basis.
- Economic: ETFs are relatively economic compared to actively managed funds since no fund management is required, leading to lower fees and administration expenses.
Types of ETFs: There are over 1,200 ETFs listed in Germany, offering various categories for private investors, including asset classes (stocks, bonds, resources), regions (Germany, Europe, worldwide), strategies (sustainability, mega trends, technology), and markets (developed countries, emerging countries).
Popularity and Future Trends: The popularity of ETFs is on the rise, evident in the increasing number and volumes of ETFs. Researchers foresee a positive development, emphasizing the role of transparency for private investors. ETFs are considered suitable for both capital accumulation and retirement savings plans.
In conclusion, ETFs provide a cost-effective, transparent, and flexible investment option for individuals seeking to participate in the value development of different indices. If you have further questions or want personalized advice, the FinMarie team is available for individual assessment appointments.