DIY Investor Magazine
/
September 2016
32
Exchange Traded Funds (ETFs) and tracker funds (also
known as index funds) both offer the key advantages of
passive investing: namely easy access to various asset
classes and instant market diversity for unbeatable
cost.
Tracker funds are the older and more limited vehicle
while ETFs are more innovative and flexible, and this
goes to the heart of the differences between the two
that you should know about.
TRADE ALL DAY VS ONCE A DAY
ETFs are listed on major stock exchanges (e.g. the
London Stock Exchange in the UK) which means they
can be traded at any time the market is open. If you
want to buy an ETF at 8am and then sell again ten
minutes later then you are free to do so.
Tracker funds, by contrast, only trade once a day.
Times vary depending on the fund but if you put in a
buy order at 8am it may not be executed until 4pm later
that day. Purchase after the daily cut-off point for the
fund and your order won’t go through until the next day.
The key difference here is that if you want the ability
to react quickly to market events - perhaps because
prices are in freefall - then ETFs are the right vehicle to
choose.
PRICE TRANSPARENCY VS FORWARD PRICING
When you trade an ETF, your broker will show you the
best price available at that moment. If you execute then
you can expect to receive that price or very close to it
under normal market conditions.
You can also instruct your broker to use limit orders that
help ensure you don’t trade above or below a price you
are comfortable with. Stop loss orders offer even more
control, enabling you to tell your broker to sell your ETF
if the price falls below a certain threshold.
Which of the two types of passive investing vehicle is right for you?
asks
Dominique Rield
, CEO and Founder of justETF
Tracker funds use forward pricing which means you
cannot know precisely what price you will get when you
place your order.
This is because a fund only calculates its price once a
day at its valuation point. Whenever you trade, you will
see the fund’s price at its last valuation point, but your
order executes at the price determined during the next
valuation point.
Prices may be similar between valuation points if
the market has scarcely moved but big changes are
possible during major upheavals, and you can’t use
limit orders with tracker funds.
DUAL PRICING VS SINGLE PRICING
When you come to trade an ETF you will notice that it
comes with dual price tags: one to buy and one to sell.
What’s more, the price you pay for an ETF will always
be slightly higher than what you can sell it for.
This is known as the bid-offer spread and it’s a cost of
doing business that’s collected by the middlemen who
connect buyers and sellers on the stock exchange.
Think of it like the small charge you pay when
converting currency to go on holiday.
That cost will normally amount to pennies though on
big ETFs that are heavily traded. Bid-offer spreads are
more likely to be narrow on ETFs that have more assets
under management (AUM) and higher daily trading
volumes.
ETFS VERSUS OLD-FASHIONED
TRACKER FUNDS
