What is an etf

In recent years, something that has become very popular is investments, because due to the economic expectations of many people, trying to get income through methods other than getting an extra job is a topic that has become popular. But trying to get into it investment world We can realize that there are many options, from investing our capital in a savings fund that gives us annual interest, to investing in riskier instruments such as derivatives or stocks. But among the entire range there are some that may be strange for those who are just starting in this world, in this case we will be talking about ETFs, a very interesting instrument with many possibilities.

What is an ETF?

Before going into the explanation that it is a ETF and how it behaves it is important to be clear about two terms. First they are investment fundsThese are an intermediary that exists between the investor and the market in which you want to invest the capital. The second term we must understand is the stock index, To facilitate the understanding of the latter, we will say that it is the average of all the values ​​that make up a specific market; It could be said that it is the way in which the information of all the components of a market is concentrated in a single data.
Now if we can begin to understand what an ETF is. Strictly speaking a ETF is an Exchange Traded Fund, and they are defined as a traded index fund, but what is this? Index funds are defined as investment funds that have a variable income, which is why they try to replicate the behavior of a stock index. To understand better, let's get to know a little about its history.

El start of ETFs It goes back to when it was found that a large part of the investment funds that are categorized in equities did not have the capacity to even be able to equal the profitability that the index that serves as its reference has. To simplify this explanation with an example, we will say the following: when an investor makes the decision to invest in the Spanish stock market, the profitability that he would obtain would be less than that of the IBEX 35.

Now, when this point was understood, the decision to build an index fund, which is easy to manipulate for the investor or manager. The basis of this is that the manager would buy the same shares that are making up the index, also they buy them in the same proportion. In this way, not only the act of investing is facilitated, since a deep knowledge of the stock market is not required, as well as the analysis of companies. But in addition to facilitating the process, there is a point of greater interest, the fact that the return offered by the index can already be achieved.

So if we try summarize what an ETF is, we can say that it is a hybrid between an index and a mutual fund. This hybrid serves two main things, firstly, it serves to facilitate the investment process, secondly, it allows the investor to achieve the profitability offered by the index, making, if there are profits, they are greater than simply investing in a fund. But does it have other advantages? The answer is yes, let's see what they are.

Advantages of ETFs

One of his most outstanding advantages is that the management commissions are much lower than the commissions of the variable income funds can be, in this way not only are the profits increased by equaling the profitability of the index, but also, the investment expenses are reduced ; without a doubt it is a great advantage for the investor. But this is not the only advantage to highlight, let's see what else ETFs offer us.

When analyzing the ETF we understood that, due to its structure, this index fund exactly follows the composition of the index; and it is because of this that the risk that the manager will make a mistake while making a decision regarding investments is greatly reduced; which, if it were to happen, would put the profitability offered by the fund at risk. However, ETFs also have some downsides that we have to take into account when making our decision of where to invest our capital.

Disadvantages of ETFs

Before continuing, it is important to mention a detail that may draw the attention of many investors, and that is that, although these commissions are lower than those of other investment funds, they are still relatively higher commissions than those that an investor would pay to have their investment portfolio. But delving further into this point we must clarify that this point applies in the long term. But at the same time it is important to consider our long-term investments because although the annual commission for an ETF is apparently annual, it is a point that will definitively define the profitability of our long-term investment.

Another point to consider is that the performance of these index funds it can be drastically reduced by what is known as the mandatory liquidity ratio, which must be maintained. In addition to considering that there are commissions that can be called hidden, which are identical to those that are presented in the rest of the investment funds that exist.

Once the previous points have been clarified, it is important that we consider that, although in the ETF theory They were created to equal the profitability of an index, in reality it is practically impossible for this to happen, because since these disadvantages exist, our net profit does not equal that offered by investing in the index directly. That is why keep in mind what was mentioned in the previous paragraph, analyze our investment in the long term, in order to have a clearer and more approximate idea of ​​how our investment will behave, and if the net profitability it offers is the desired one. for us.

What disadvantage does the simple fund, the index fund offer?

The main difference is noticed when comparing the profitability that we obtain from a Stock index; In order to improve the skills of our readers we will give a basic advice to be able to make good decisions. Comparing the profitability is essential, this is because when we do it we can see that the stock market indices do not reflect that companies have to pay dividends; Once we understand this point, it is important to emphasize that we conclude that the profitability of the funds themselves is much lower than it might appear when compared to the profitability of an investment made directly in the stock market.

ETF behavior

An ETF has a theoretical price; This is calculated based on the factors such as the price of the index, the commissions that have to be covered, the dividends that exist, among some others. However, this theoretical price is not noticeably different from the actual price, but it does have a difference in the way it is calculated; This main difference lies in the fact that the real price is based in a direct way on the supply and demand that exists; a very important point to keep in mind.

Now, regarding the liquidity that an ETF has, we are talking about a fact that is guaranteed by the entities that have committed to being able to offer a differential that is in the buy and sell.

In order to conclude successfully with this article we will put an example of how a ETF manager in a real situation. In the event that the price of the ETF is increased over the theoretical value of said ETF, the manager should buy shares of the market, to later be able to create partitions of the ETF; the next step would be to sell them at the moment when the real and theoretical prices are balanced again.

On the contrary, if the actual ETF price e is below the theoretical value, the manager should buy shares in ETF and then be able to decompose them, the next thing would be to sell the shares in the stock market, this until the theoretical and real prices are balanced again.

Once we have understood all of the above, we can say that an ETF behaves according to the index, so that if the benchmark for the ETF increases by 15%, the ETF will also increase by 15%; Conversely, if the index falls in value by 9%, the ETF will also fall by 9%. Although despite this behavior, profitability is not the same due to the previously analyzed factors.

Another good news is that if you are thinking about invest in ETFs, There is no investment kit, so it may or may not be a very good investment option. Once you as an investor have all this information, it is time to make a decision on whether or not to invest your capital in ETFs.