INVESTMENT CLINIC: Is it too risky to put my £10,000 in exchange-traded funds?

By Holly Black For Money Mail

Updated:

I have £10,000 to invest and I’m thinking about putting it in ETFs as I’ve heard they are cheap. Are they risky?

An ETF, or exchange traded fund, is a type of tracker fund which follows the performance of a particular stock market. What makes an ETF different to a normal tracker fund is that you buy and sell them like company shares.

ETFs are listed on a stock exchange and can be bought and sold at any time through a broker or fund supermarket. They are very cheap to own — some with charges as low as 0.07 per cent a year. And they are largely no more risky than any other tracker fund.

Exchange traded funds are a type of tracker fund which follow the performance of a particular stock market

Exchange traded funds are a type of tracker fund which follow the performance of a particular stock market

There are two types of ETF, physical and synthetic.

Physical ETFs actually buy the shares in the market they are tracking. So if you have a FTSE 100 ETF it will own shares in all 100 companies in that index, or it might own a sample of them to keep costs down.

Synthetic ETFs don’t own shares, they are based on tricky financial instruments called derivatives. This means they don’t have to own 100 shares which have to be bought and sold each time a company joins or leaves the FTSE 100. Instead they buy a promise from another company, that it will deliver the same return to the fund as the stock market.

The risk here is called counterparty risk, which means if the company providing the return goes belly up, so does the fund.

Synthetic ETFs have a bit of a bad name as people got stung by derivatives in the lead-up to the financial crisis when many companies went bust.

Most ETFs which track stock markets are physical and they are the safer option of the two. Synthetic funds may be marginally cheaper because they don’t have to buy and sell shares but the difference will be pennies per annum so it’s not really worth taking the extra risk.

If you want to track something less ordinary, perhaps the price of gold or commodities such as cocoa or coffee, then you will be buying a synthetic ETF because a fund can’t really buy up bucket loads of coffee beans to buy and sell. These are riskier areas to invest in, so the structure of your ETF is not the biggest risk consideration if you’re putting money in volatile assets.

As a relative newbie to investing it’s probably best to stick to major stock markets such as the FTSE or American S&P 500.

 

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