- What is an Exchange Traded Fund (ETF)
- Types of ETFs
- Benefits of investing in ETFs
- How to invest in an ETF
Many people may have heard the terms stocks, bonds and commodities, but have you heard the term Exchange Traded Fund (“ETF”) before? An ETF is an investment fund that tracks the performance of the market index. ETF helps to diversify your risk and you can start with a small amount of money, by just investing $100 per month. Yes, just $100 per month and you can invest in 30 Singapore companies. Read on to find out how you can get started IMMEDIATELY!
2. What is an ETF?
An ETF is an investment fund that replicates the performance of a market index, such as Straits Times Index, S&P 500, Dow Jones Index, Bond Index, etc. By investing into an ETF, this means that you are diversifying your portfolio by buying into companies that are underlying the index, without having to buy individual company stocks, bonds or commodities. Our Singapore Straits Times Index (“STI”) is a great example. As at 16 September 2016, the following are the 30 companies that are within the STI:
I believe that you would have heard at least half of the companies in the list stated above if you are residing in Singapore. These are well known Blue-Chip companies. If you want to invest in the individual company that is within the STI, you will have to buy them through your brokerage account individually. For example, if you want to invest in 100 DBS shares, it would cost you $1,516 (100 shares multiply by $15.16/share which is the closing share price as at 16 September 2016). If you want to invest in 100 UOB shares, it will cost you $1,886 (100 shares multiply by $18.86/share which is the closing share price as at 16 September 2016) excluding the brokerage fees. Am I right to say that if you want to invest in all the 30 companies found in STI, it will definitely cost you a lot more as compared to just $100? What if I told you it’s possible to invest in ALL 30 companies just by using a mere $100 per month? Wouldn’t it be more affordable? Before I share with you How to Invest in ETFs, let me share with you the common types of ETFs in Singapore.
3. Types of ETFs?
There are many types of ETFs around the world, but to keep things simple, we will talk about the 2 common ETFs in Singapore. One is SPDR Straits Times Index ETF and the other one is Nikko AM Singapore STI ETF.
We will take the example of Nikko AM ETF for illustration purpose. The closing price was $2.93/unit, as at 16 September 2016. If you buy 100 units, it will cost $293. This means with just $293, you are buying into the 30 companies in the STI, without requiring the effort to analyse each company’s performance. This ETF automatically tracks the performance of STI. If the STI goes up, the unit price for this ETF will go up also. Similarly, if STI goes down, the unit price for this ETF will go down also. For better illustration, refer to chart below, you can see clearly that Nikko AM STI ETF performs almost the same like STI Index and there is only a slight difference.
If you buy this STI ETF since its inception in year 2009, the annualized return is around 10.74%, assuming all dividends and distributions are reinvested. Such returns are pretty good as compared to the banks’ interests which are mostly less than 1% annum.
The slight difference between Nikko AM STI ETF and STI Index is called tracking error, which is standard deviation between the STI ETF performance and STI Index performance. In this case, the smaller tracking error will be better. The tracking error happens due to expenses incur for the fund, such as fund management fees, trustee fees, etc.
In Singapore, there are 3 types of ETFs that tracks performance of stock market, bonds and commodities such as gold. The principles underlying the ETFs are the same, whereby it is tracking on some form of index. For bond ETFs, it tracks on a basket of bonds and for Gold ETF, it tracks the gold index. Since ETFs mirror the index, there are 2 main ways that these mirroring are done. The first way is Cash-Based ETF and the second way is Synthetic Replication ETF.
For Cash-based ETF, it simply means that the ETF holds same stocks in the same proportion as the weights of the constituent stocks in the benchmark index or holds a sample of constituent securities that statistically represents the index. For example, if an index contains 1.2% of Apple Inc stocks, then this Cash-based ETF will also contains 1.2& Apple Inc stocks.
For Synthetic Replication ETF, it uses swaps or other derivative instruments to replicate the index instead of physically holding each of the stock in its index. These derivative vehicles are agreements between the ETF and a counterparty—usually an investment bank—to pay the ETF the return of its index. In essence, a synthetic ETF can track an index without actually owning any of its securities. Because they don’t physically hold the securities in which they invest, synthetic ETFs can provide a competitive offering for investors seeking to invest in harder-to-access markets, less liquid benchmarks, or other difficult-to-implement strategies that would otherwise be very costly and difficult for physical ETFs to track.
4. Benefits of Investing in ETFs
a) Low management fee – 1 important characteristic of ETF is that this ETF fund also requires fund manager to manager to manage it. Therefore, we need to pay the management fees, trustee fees, audit fees, etc. However, as compared to traditional unit trust products, the fees paid to Index Fund Managers are much lower. For example, for Nikko AM ETF, management fee is 0.20% per annum, and trustee fee is up to 0.045% per annum. On the other hand, for Unit trusts, the annual management fee is around 1% – 2%. Some even charge performance fee of few percent if the fund hit the performance targets.
In addition, for traditional unit trust products, the sales charges upon buying the fund is 5%, where this is not found in ETFs. For ETF, the normal brokerage fee applies. With lower management fees and sales charge, this effectively reduces our investment cost.
b) Dividends – STI ETF also distributes dividends. On average, STI ETF has around 3% to 4% of dividend yield per annum. This means that other than enjoying the benefit of unit price increase (capital appreciation), investors also enjoy the dividends, which effectively increase the investment return.
c) Liquidity – ETFs are very liquid, especially for STI ETFs. Investors can buy and sell anytime in the stock exchange when the market opens just like shares. The normal brokerage fee will apply for buying and selling ETFs.
d) Passive investment/long term investment – this is beneficial if you are a patient investor. Depending on market and economy condition, shares, bonds and commodities may perform differently in different time zones. As you can see in the chart above, STI performs up and down for past 8 years. In short term, it looks rocky or even negative return. However, in long term, it generates decent return of annualized close to 10%. This is a good investment instrument if you can wait patiently. You can also sleep soundly during economic crisis.
5. How Can I Get Started Immediately?
As a start, the simplest way to invest in ETF will be to invest in STI ETFs which tracks the Straits Times Index. Currently as at Sept 2016, Monetary Authority of Singapore classify 26 out of 81 ETFs as Excluded Investment Product. This means that you can freely buy and sell the product without having to do Customer Account Review (CAR) or take the SGX Online Education Programme (means you do not have to take exam to prove that you are qualified to invest in higher risk financial products). STI ETFs, some bond ETFs, gold ETF and others can be bought like those blue chip shares. As mentioned above, in Singapore, there are 2 ETFs that track the STI, SPDR Straits Times Index ETF and the other one is Nikko AM Singapore STI ETF. The differences between these 2 are the Fund Managers, the expenses, such as management fees, trustee fees, etc.
There are 2 ways of investing in STI ETF. You can do it either by buying directly through brokers, or by investing regularly, such as investing monthly with a fix sum through banks/brokers.
For the first method, based on the last closing price, you can enter quantity that you want to buy and pay a one-time brokerage fee. However, for this method, it depends on your skill and luck in reading market trends, you may get it at higher price or lower price, depending on the stock price.
As for the second method, you can do it through a regular savings plan (RSP), by investing minimum $100 per month into such plans. This is an effective way for you to force yourself to save money. In addition, the plan will help you to automatically invest this fixed sum into the ETF on a monthly basis. You can set up GIRO to deduct this investment amount automatically from your bank account. There are 4 companies that provide such RSP, and different companies name the plans differently, but they are referring to the same thing. See below for the different types of RSPs:
For the POSB Bank and OCBC bank investment plan, it can be done through online e-banking, whereas for Philip Securities and Maybank Kim Eng, you will need a trading account with them. Choose the way that you are most comfortable with and after comparing the fees. I personally use the POSB RSP. You just need to go to the nearest ATM Machine, insert in your ATM Card, and search for the RSP Set Up. By default, the amount is S$100. Once you agree with the terms and conditions, your RSP will be set up within minutes.
One thing to take note is that for every month, you are investing a fixed sum of money (eg. S$100 into STI ETF) on a fixed date regularly. Such method of investing is called Dollar Cost Averaging (DCA). As such, this is done automatically and you do not have to time the market. That will free you from all the work and emotions. Just imagine that you are able to beat inflation, the banks’ interest and most of the professionally managed funds by simply doing NOTHING!
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Research Analyst, Mind Kinesis Value Investing Academy
Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.