Investing in ETFs and trackers: how does it work?

Etf graphs

In a context where the values of financial securities in the markets fluctuate significantly, more and more savers are choosing to invest in the stock market. To invest in the financial markets, you can choose to select the company’s shares yourself, but you can also opt for ETFs, also known as trackers. This is a financial product, which appeared in the early 1990s, that allows anyone to invest in a fund whose performance tracks that of a pre-defined index, such as the CAC40. Why is this an investment that more and more investors are interested in, and how do you invest in ETFs and trackers? Discover our guide.

What is an ETF?

An ETF (Exchange Traded Fund), also called a tracker or index fund, is a mutual fund composed of bonds and shares of several hundred companies or several states (for bonds). The performance of an ETF replicates that of a particular stock index and therefore tracks its performance. Portfolio management is therefore passive: there is no particular strategy for outperforming the market. Switching to ETFs is a fairly straightforward way of investing in the stock market, with little management on your part.

ETFs are therefore mutual funds that aim to replicate a stock index. For example, an ETF may have the CAC 40 as its benchmark. So when you invest in this tracker, it is as if you are investing in all the CAC 40 companies simultaneously. The return on your investment will therefore be more or less the same as the CAC 40.

This operation differs from that of other investment funds. In fact, if it invests in a SICAV or a FCP, the management company selects the assets of its choice in the hope of doing better than the market. But it can also perform worse, which is usually the case (in more than 80% of cases, in general). 

In trying to beat the market, this fund also has significant costs. In fact, you have to bring together a whole team of analysts to make complex decisions, which can have significant costs for you. These costs therefore reduce your return. With ETFs, there is not the same type of arbitrage for the fund: they have to invest in all the relevant securities, which is usually done with a lot of automation. The costs are therefore lower for you.

However, you can use actively managed ETFs that do not automatically track an index. Such trackers are much rarer and costs are higher due to the more advanced management required of the fund, making them less attractive.

The advantages of ETFs

ETFs allow you to easily diversify your stock market investments. In fact, thanks to this type of fund, you invest in many securities at the same time. This allows you to dilute the risk inherent in this type of investment.

Trackers also allow you to pay relatively small fees, which preserves the return on your investment. Fees are typically 5-10 times cheaper compared to investing in a traditional fund – 2% per annum versus 0.25% per annum on average for ETFs. You also do not have to do any special management on your own. This is therefore a major advantage over direct stock market investment.

It also benefits from good transparency and flexibility. In fact, ETF liquidity is good if you generally want to resell your securities, unless you have invested in a somewhat exotic fund. These securities are listed continuously throughout the day, so you can resell them at any time. In terms of transparency you know exactly what you are investing in. Therefore, you will not be able to deal with strategic fund reversals.

In terms of performance, it is very difficult to outperform the market. As a result, almost 80% of the funds that are not indexed in the market do not outperform the average return. By investing in ETFs, therefore, you take less risk with respect to your investment performance.

Eddie Erwing

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