ETF funds: what are they in simple words, pros and cons, types

Want the ease of stock trading but the diversification benefits of mutual funds? Take a look at exchange-traded funds (ETFs) that combine the best of both.

This article provides information and education for investors. Ardma.ru does not offer advisory or brokerage services, and does not recommend or advise investors to buy or sell specific stocks or securities.

Exchange-traded funds are a type of investment fund that offer the best characteristics of two popular assets: They have the diversification benefits of mutual funds while mimicking the ease of trading stocks.

What is an ETF on the stock exchange in simple words?

An ETF is a fund that can be traded on an exchange like a stock. This means they can be bought and sold throughout the trading day (unlike mutual funds, whose prices are set at the end of the trading day). ETFs give you the ability to buy and sell a basket of assets without having to buy all the components separately, and they often have lower fees than other types of funds. Depending on the type, ETFs have different levels of risk.

But like any other financial product, ETFs are not a one-size-fits-all solution. Evaluate them on their merits, including management costs and fees (if any), how easily you can buy or sell them, and the quality of their investment.

Taxes and dividends

If after purchasing shares of a mutual fund (ETF), registered in Russia under the Federal Law “On Investment Funds” dated November 29, 2001 N 156-FZ (see letter of the Ministry of Finance of the Russian Federation dated November 25, 2004 N 03-03-01-04/1/ 153), the investor does not pay tax on dividends received directly to the fund and reinvested by the fund itself, then when purchasing Sberbank shares directly, dividends are transferred directly to the investor, and income tax on them will be withheld automatically by the broker. And there is no way to avoid it - neither by purchasing shares in an individual investment account, nor by holding shares for three years. If you receive dividends, 13% is automatically sent to the state. But if the return on Sberbank shares is below 7%, the tax will be exactly 0.9% of the investment amount - that is, it will be equal to the fund’s commission, so the investor will not lose anything, and if the value of the shares increases and/or dividends decrease, he will also reduce his expenses.

How do ETFs work?

An ETF works like this: The fund provider owns the underlying assets, creates a fund to track its performance, and then sells shares of that fund to investors. Shareholders own a portion of the ETF, but do not own the underlying assets of the fund. Even so, investors in an ETF that tracks a stock index may receive lump sum dividend payments or reinvestments on the stocks that make up the index.

While ETFs are designed to track the value of an underlying asset or index—whether a commodity like gold or a basket of stocks like the S&P 500—they trade at market prices that typically differ from the prices of that asset. Moreover, due to things like expenses, an ETF's long-term return will differ from the return of its underlying asset.

Here's a shortened version of how ETFs work:

An ETF provider looks at a collection of assets, including stocks, bonds, commodities or currencies, and creates a basket of them with a unique ticker symbol.
Investors can buy a share of this basket, just as they would buy shares of a company.
Buyers and sellers trade ETFs throughout the day on an exchange, just like stocks.

Risks and returns

Now let’s evaluate the profitability and risks of investing in the FXRL fund in comparison with investing directly in Sberbank shares. Table 1 shows data for 5 years (since FinEx ETFs appeared relatively recently). There are no special surprises here - yes, the risk of investing in individual shares is one and a half times higher than the risk of investing in the FXRL broad market index fund, but the return on investment increases even more - 29% per annum versus 19%, and this does not take into account dividends on Sberbank preferred shares ! As they say, everyone can choose for themselves. If we want higher returns, we buy Sber Pref shares; if we want lower returns, we buy just Sber. And if you don’t want a completely increased risk, we continue to invest in index exchange-traded funds, for example, FXRL.

ETFs and mutual funds

Generally speaking, ETFs have lower fees than mutual funds (MIFs)—and that's a big part of their appeal. In 2022, the average annual administrative expense (also called expense ratio) for mutual funds was 0.52%. The average expense ratio for ETFs was 0.18%.

ETFs also offer tax efficiency benefits to investors. Typically, turnover within a mutual fund (especially an actively managed one) is higher than that of an ETF, and such buying and selling can result in capital gains. Similarly, when investors go to sell a mutual fund, the manager will need to raise cash by selling securities, which can also generate capital gains. In any case, investors will be forced to pay these taxes.

ETFs are becoming more popular, but the number of mutual funds available is still higher. The two products also have different management structures (usually active for mutual funds, passive for ETFs, although actively managed ETFs do exist).

Differences between ETFs and mutual funds

The essence of these two types of funds is approximately the same, but let's see how they differ.

Information on the status of ETF securities can be obtained at any time; the status of mutual fund shares can be found out once a quarter;
The fund's commission is 1%, 3-4% goes to the management of the mutual fund;
When purchasing securities of an exchange-traded fund, you simply need to do it online. It's easy. When purchasing mutual fund shares, you must personally come to the mutual fund office to do this.

ETFs and shares

Like stocks, ETFs can be traded on exchanges and have unique tickers that track their price activity. Unlike stocks, which represent only one company, ETFs represent a basket of stocks. Because ETFs contain multiple assets, they can provide better diversification than a single stock. This diversification can help reduce your portfolio's exposure to risk.

ETFs are sometimes concentrated around certain sectors or themes. For example, SPY is one of the ETFs that tracks the S&P 500, and there are fun ones like HACK for a cybersecurity fund and FONE for a smartphone-focused ETF.

Do the funds pay dividends?

Yes and no.

The European model assumes full reinvestment of dividends. Incoming cash flow increases the price of the fund's shares.

Owners of American ETFs receive constant payments from dividends or coupons. Payments generally occur 4 times a year (every quarter). Less than 2 times a year. There are funds that pay divas every month. But there are few of them.

Of course, both European and American ETFs have exceptions. Some Americans may choose to reinvest instead of paying divas. Like the Europeans, pay out money to their shareholders.

But the majority of funds work this way.

What is in Russia?

Introduced in 2013, Finex ETFs initially paid dividends. But after a year they abandoned this practice. And we switched to the European model of income reinvestment.

ETFs and BPIFs traded on the Moscow Exchange do not pay dividends.

The exception is the RUSE ETF from ITI Funds. Investing in the Moscow Exchange index. Once a year, the provider accrues dividend income to shareholders. Real money.

Pros and cons of ETF funds

US-listed ETFs saw $507.4 billion in flows in 2022, according to ETF.com (a subsidiary of the Chicago Board Options Exchange). This number is 55% higher than ETF inflows in 2022. Investors have flocked to ETFs because of their simplicity, relative low cost, and access to product diversity.

Pros of investing in ETFs

Diversification . While it's easy to think of diversification in terms of broad market verticals—like stocks, bonds, or a specific commodity—ETFs also allow investors to diversify horizontally, like industries. It takes a lot of money and effort to buy all the components of a particular basket, but with the click of a button, an ETF will bring those benefits to your portfolio.
Transparency . Anyone with internet access can track the price activity of a particular ETF on an exchange. In addition, the fund's holdings are disclosed to the public every day, whereas with mutual funds this happens monthly or quarterly.
Tax benefits . Investors are typically taxed only when they sell an investment, whereas mutual funds bear that burden while investing.

Disadvantages of Investing in ETFs

Trading expenses . ETF costs cannot be limited by expense ratio. Because ETFs are exchange traded, they may incur commissions from online brokers. Many brokers have decided to reduce ETF fees to zero, but not all have done so.
Possible liquidity problems . As with any value, when it comes time to sell, you'll be dependent on current market prices, but ETFs that don't trade as often will be harder to sell.
Risk of ETF Closing . The main reason for this is that the fund did not bring in enough assets to cover administrative expenses. The biggest disadvantage of closing an ETF is that investors must sell sooner than they might have expected, and possibly at a loss. There's also the annoyance of having to reinvest that money and the possibility of an unexpected tax burden.

Where to buy ETFs?

Since ETFs are traded on the stock exchange, you can buy them there. To do this you will need to gain access to trading. Through a broker.

A broker is an intermediary between investors and the exchange.

The algorithm is as follows:

Choose a reliable broker with adequate rates.
You enter into a brokerage service agreement with him (many allow you to open an account online, without visiting the office).
You fund your account and make transactions (purchase ETFs) through a trading terminal or mobile application.

How to choose a stock market broker?
The best Russian brokers for beginners.

Exchange-traded funds can be purchased:

on the Moscow Exchange (access is provided by any Russian broker);
on the St. Petersburg stock exchange (not all brokers have access);
through a foreign broker.

ETF on the Moscow Exchange

Almost 3 dozen ETFs and mutual funds are available to investors. Mainly on stock and bond indices. Developed (USA, Germany, England, Japan, Australia), developing (China, Russia, Kazakhstan) markets.

Both from providers (FINEX, ITI) and the largest banks (Sberbank, VTB, ALFA, Gazprombank).

The current list of all funds available for purchase can be viewed on the Moscow Exchange website. Quotes, name, stock ticker and description of the ETF (presentation).

ETF on the St. Petersburg Exchange

The St. Petersburg Stock Exchange trades foreign ETFs. There are currently 77 funds available from the world's leading providers:

Vanguard;
iShares;
SPDR;
Invesco.

The current list of ETFs can be viewed on the St. Petersburg Exchange website.

ETF trading is closed to ordinary mortals. Qualified investor status is required.

Foreign ETFs

The number of ETFs available for purchase in Russia is negligible. The problem is solved by contacting a foreign broker. As a result, the investor gets access to several thousand global ETFs. With lower commissions.

Important! The benefit of purchasing an ETF with a lower management fee (hundredths of a percent) may be offset by the higher costs of maintaining a foreign brokerage account.

In other words. Owning foreign ETFs will be much cheaper. But the total commissions for transactions + a possible mandatory monthly fee to a foreign broker are many times more expensive.

As a result, contacting a foreign broker will be advisable with a certain amount of capital. From 10-15 thousand dollars minimum.

Info on the topic: How much is it profitable to work with a foreign broker?

What ETFs can you buy? What are their profitability, expenses, dividends?

There are 2 resources that provide information on most of the world's ETFs. With the ability to filter and search for the funds you need:

etfdb.com;
etf.com.

How to Find the Right ETFs for Your Portfolio

It's important to know that while ETF costs are generally lower, they can also vary widely from fund to fund, depending on the issuer, as well as complexity and demand. Even ETFs that track the same index have different costs.

Most ETFs are passively managed investments; they simply track the index. Some investors prefer the hands-on approach of mutual funds, which are managed by a professional manager who tries to do better than others in the market. There are actively managed ETFs that mimic mutual funds, but they have higher fees. So consider your investing style before purchasing.

The explosive growth of this market has also led to the introduction of some funds into the market that may not have merit - gimmicky funds that occupy a thin slice of the investment world and cannot provide much diversification. Just because an ETF is cheap doesn't necessarily mean it fits your broader investment thesis.

ETF Benefits

This concerns Russian funds again.

If you own securities for more than 3 years, you are exempt from tax on the increase in market value. By 3 million each year.

It is possible to purchase ETFs within an IIS. And the right to claim 2 types of tax deductions (to choose from):

13% refund of the account replenishment amount;
exemption from capital growth tax.

“Foreigners” cannot offer similar tax breaks to non-residents.

Useful: Everything you need to know about IIS before opening

How to invest in ETFs

There are many ways to invest in ETFs, and how you do it depends largely on your preferences. For practical investors, investing in ETFs is just a few clicks away. These assets are a standard offering among online brokers, although the number of offerings (and associated fees) varies by broker.

At the other end of the spectrum, robo-advisors build their portfolios from low-cost ETFs, giving investors access to these assets. One trend that has been good for ETF buyers is that many major brokerages have reduced their commissions on stock, ETF and options trades to $0.

Despite its simplicity, ETFs have nuances that are important to understand. Armed with the basics, you can decide if an ETF is right for your portfolio and embark on the exciting journey of finding one or more.

How is the management fee calculated?

The so-called ETF management fee is indicated as a percentage of NAV (net assets). For an annual interval. But it is charged daily. Proportional to the holding period of the fund's shares.

For example. The indicated management fee is 1.1% per year. An investor buys 10 ETF shares for 10,000 rubles.

The fund's daily commission will be about 0.003%. Or 30 kopecks a day.

The money is debited from the value of the fund's shares. By making the estimated price of one ETF less by the amount sought. In our case, 3 kopecks per share. For each day of ownership.

etf

ETF - What is it in simple words

sova

| 25-01-2020, 08:12 | Hi all! In this article, we have a difficult, but interesting task to figure out what ETFs are, how they work and how to make money from it.

What is an ETF in simple words:

ETF
is an exchange-traded product that allows you to become the owner of several shares at once for relatively little money. width=”440″ height=”238″[/img]

Suppose an investor has 10,000 rubles and a desire to invest them in shares. But he does not want to invest all his money in the shares of just one company - since if things do not go well for this company, he may suffer significant losses. But he doesn’t have enough money to invest in the assets of several companies at once in order to reduce the risks of his investments. This is where ETFs come to the aid of a novice investor. ETFs contain a large number of shares (or other stock assets) and their cost starts from $10 (610 rubles). Thus, thanks to ETFs, an investor with a small starting capital can get a full-fledged, diversified investment portfolio.

Thus, a person can buy an ETF called FXRL and become the owner of all the shares included in the RTS (Russian Trading System) index.

What is a stock index?

Most often, an ETF is tied to a so-called “stock index.”
What is a stock index? A stock index is an indicator of the state of the stock market, calculated based on the price of the most liquid (popular) shares traded on a given exchange. That is, the exchange selects several shares (usually 15-30 pieces) that are in greatest demand and adds their price indicators together and uses the resulting number as an indicator of the state of trading on the exchange (this indicator is often used as one of the indicators of the state of the country’s economy as a whole). The company that issues the ETF, to fill it, uses the same assets in the same proportion as the exchange to compile the index, then gives this ETF a name, for example, “FXRL” (this is an ETF consisting of shares included in the Moscow Exchange index). And it releases parts of this ETF for free trading on the exchange. An investor can buy a share (piece) of this ETF and become the owner of a portion of all shares included in the ETF. The cost of such an ETF changes following the rate of the stock index indicator - the rate rises, the value of the ETF increases, the rate falls - the value of the ETF also falls. That is, the price of an index ETF changes depending on the fluctuations of the index.

How it works.

ETF is a package containing a large number of stock assets. Due to this, it provides the widest possible diversification.

Mutual Funds or ETFs

What is a mutual fund?

A mutual fund
is a method of collective investment in which investors become owners of shares in the fund’s property. The company's specialists manage the purchase and sale of assets.

What is an ETF?

An ETF
is an open-end investment fund whose shares can be purchased on a stock exchange. After purchasing an ETF, the investor becomes the owner of a portion of the company's assets. ETFs usually consist of a pre-compiled list of assets or copy the composition of stock indices.

The idea of ETF and mutual fund is similar - it is a collective investment in exchange-traded assets. And in comparison, an ETF is simply a more convenient, transparent and accessible analogue of a mutual fund, the emergence of which was prompted precisely by the development of IT technologies that make it possible not to work (unlike mutual funds) with clients directly, but to place your units (shares) for free purchase directly on the exchange. In a situation with a mutual fund, the investor needs to go to the company’s office and enter into a contract with it to purchase a share. Of course, this can be done through the website of the management company, but in this case there will be not much less bureaucratic fuss, and in some cases even more. You can also sell your shares only through the management company, on the company’s website, by coming to the office or by calling (shares of some mutual funds are also traded on the stock exchange, working with them is also extremely inconvenient). That is, “ETF” is an evolved “mutual fund” that meets modern requirements and standards. The difference between them is about the same as between sending letters via mail and sending emails.

Thus, the main difference between a mutual fund and an ETF is the transparency and ease of working with the latter.

About ETFs in Brief

Each ETF fund itself decides on what principle it will choose stock assets. But more often than not, the composition of the ETF is completely identical to the world currency, stock or commodity indices.

ETFs do not provide 100% guaranteed returns. Their value is always tied to some assets; if the value of these assets decreases, the value of the ETF tied to them will also decrease.

You can get acquainted in advance with information about how an ETF fund distributes dividends and income from bond coupons on the website of the management company or in the reference information on the website of the exchange that hosts the ETF.

ETFs are freely traded on a stock exchange, in the same way as regular stocks. At any time you can buy/sell them at the market price.

Money in a brokerage account, unlike a bank account, is not insured by the state. If the broker goes bankrupt, there is a risk of losing money. This applies not only to ETFs, but to any securities.

Pros of ETFs

Possibility of investing in foreign shares.
For Russian investors, the use of ETFs provides the opportunity to invest their funds in foreign assets in the simplest and most convenient way available on the market.
For example, in order to purchase 1 share of a company like Amazon, an ordinary investor will need $2,000 (130,000 rubles) of available funds, a foreign brokerage account and the status of a qualified investor. To purchase an ETF, a future investor needs to take only two steps - open an IIS from any Russian broker that provides access to the Moscow Exchange (you can now do this without even leaving your home), download the broker’s mobile application and purchase the required ETF there, or buy an ETF through the QUIK trading terminal ( on our website there are instructions on how to do this) also provided by the broker after opening an account. +

Low commission The commission charged by the company providing its ETFs for purchase is approximately 0.2 - 1% per year. For example, the commission when investing in open mutual funds varies from 1 to 5% per annum. Under these conditions, even if the investment portfolios of ETFs and mutual funds consist of the same assets in the same proportions, the ETF will show higher returns due to lower commissions. Also, a novice investor should take into account the fact that many brokers use increased commissions for small (on average 50,000 - 100,000 rubles) deposits. In these conditions, manually setting up an investment portfolio entails additional costs, which can greatly affect the financial situation. investment efficiency. Buying an ETF in this case is the best choice, reducing the cost of commissions to the broker.

Transparency and accessibility. As a rule, the composition of the assets included in a particular ETF is clearly regulated and open for review. In comparison, ETFs' closest relatives, mutual funds, familiarize investors with the composition of their assets only once a month. The rest of the time, mutual funds offer their clients a so-called investment declaration. It most often indicates which part of the portfolio consists of stocks and which bonds. The area in which the issuer company operates, whose shares are included in the portfolio, can also be indicated, for example, IT industry, oil production, etc.

Disadvantages of ETFs.

—
Rigidity. For me, the main disadvantage of investing in ETFs is the low variability and rigidity of this instrument, that is, what is at the same time the main advantage of ETFs. When buying an ETF, you buy the proposed package of shares and cannot exclude from it the shares that you need or, on the contrary, add some shares to it - this is a ready-made product without the ability to make changes. And this is absolutely normal for a novice investor who does not yet have enough experience and knowledge to independently compile an investment portfolio. But over time, when you acquire the first skills necessary for analyzing securities - you will begin to better understand technical or fundamental analysis, you will also understand that it is better to refuse to buy some stock assets at the moment (for example, an understanding that the shares of company N are greatly overvalued ), while others are better to buy more of, as they have greater growth potential and higher dividend yield. With an ETF, this number does not work - the assets are assessed in advance by the company’s specialists, trading robots called “Robo-advisers,” or the shares are simply purchased in exact accordance with any stock or futures index. Thus, an ETF is a tool that is ideal for novice investors at the very start of their journey, or for people who are not ready to spend a lot of time conducting analysis to select the shares they need and just want to get a finished product.

—

Not the widest choice. There are more than 1,000 different ETFs in the world. The Moscow Exchange provides access to only 15 of them.

ETF Dividends

Most often, the scheme used by ETF funds does not involve the payment of dividends. But where do the dividends paid on shares purchased by the fund go? The answer is simple - they are reinvested. That is, with money from dividends, the ETF fund buys new shares, which results in a compound interest effect, which ultimately leads to an increase in the ETF's profitability. But some ETFs still pay dividends to their investors. For example, “ RUSE
” - an ETF available on the Moscow Exchange consisting of shares included in the RTS index (Sberbank, Gazprom, Lukoil, etc. Blue chips) pays dividends from the shares available in the fund’s assets. This is the only dividend-paying ETF available on the Moscow Exchange. There are also several dividend-paying ETFs in the world, but compared to ETFs operating on a “reinvestment model,” their number is very limited. Why is that? The thing is that paying dividends is not entirely convenient both for the fund itself and for the investor. And if the reason for the inconvenience for the fund is quite clear, it is necessary to keep records of investors, calculate the amount of payments, etc. What is the inconvenience of receiving dividends for the ETF holder. The main disadvantage is income taxation. Previously, dividends were subject to income tax at a reduced rate - 9%, but recently it was raised to the standard 13%, which made receiving dividend payments not so profitable. In the case of reinvestment of the received dividend income by the ETF fund (and not payment to investors), this tax is not charged, which ultimately results in benefits for both the fund and the investor.

How to buy ETF

You can purchase any of the 15 ETFs presented on the Moscow Exchange by opening a brokerage account or IIS (Individual Investment Account) with any Russian stock broker.
Basically, brokers provide two platforms for working with securities and derivatives - a mobile application and a special trading terminal for desktop PCs. There is an article on our website about how to buy ETFs through the QUIK terminal. In this article you can find step-by-step instructions. Well, that's all! If you still have any questions, you can ask in the comments below the article. Good luck with your ETF investing. And all the best.

FAQ - answers to frequently asked questions

6.1. What ETFs can you buy on an IIS?

IIS is a regular brokerage account. All listed ETFs on the Moscow Exchange are available on it.

You can also buy foreign ETF funds. However, many brokers restrict access to them to individuals who do not have the status of a qualified investor.

Many people ask about gold ETF. There are three options available for individuals: FXGD, VTBG, TGLD. All of them are available for purchase on IIS.

How to trade gold on the stock exchange;
How to trade silver on the stock exchange;

6.2. Which ETFs are better to buy to make money?

There are several types of ETFs:

For bonds (government bonds and Eurobonds);
For shares (index);
For goods (only gold is available for now);
Mixed;

The choice of ETF depends on the investor's goals. One of the best solutions is to create a portfolio of different types to create maximum diversification.

1 Safe briefcase. For example, for those who do not want to take risks, bond funds (SBRB, SBGB, FXRB, VTBB) are suitable. You can also pay attention to Eurobond funds (FXRU, RUSB, SBCB).

And, of course, it is worth noting FXMM and FXTB, which are considered the safety benchmark as they represent a collection of short-term US Treasuries.

2 Risky (more profitable in the future). Equity funds provide superior returns over time. It makes sense to accumulate them for those who are not afraid of market volatility and invest for the long term.

For example, the FXRL and SBMX funds are popular in our market. Foreign popular options: FXUS, FXIT and new FXWO, FXRW to global markets.

Which ETFs are best to buy today;
ETF yield on the Moscow Exchange;
Stock return - what is it made up of;
Investing in shares - what investors need to know;
How to make money on the stock exchange;

3 For goods. FXGD (gold) is well suited for hedging the risk and devaluation of the ruble. There are also overseas gold and silver funds, but most brokers do not provide access to them for unqualified investors.

4 Mixed fund. So far, this type of ETF is a novelty. Only Tinkoff has created a choice of 3 such funds. They contain a higher percentage of gold (25%). As history shows, it grows in price very unevenly, so this type of asset can greatly hinder the growth of a stock portfolio.

Using different ETFs you can implement a perpetual portfolio:

Eternal investment portfolio;
Ray Dalio All-Weather/All-Season Briefcase;
How to create an investment portfolio;

6.3. Can an ETF go bankrupt?

This question often worries beginners. This should be answered with a counter question: “why would an ETF go bankrupt?” He has no debts. This is simply a collection of assets managed by a company that adheres to certain proportions: the value of the share and the total value of assets.

In world practice, large ETF funds have not gone bankrupt, but they may close due to weak popularity. On the Russian market, FXJP, FXAU, FXUK were liquidated due to lack of interest from investors. Those who did not sell them received money equivalent to their value at the time of liquidation. Instead, two global funds FXWO and FXRW were created.

ETF - questions and answers;

What is better - buying in dollars or rubles?

On the Moscow Exchange, the same ETFs are traded in two currencies: rubles and dollars.

What is better and more profitable for an investor?

The answer is simple - buy ETFs in the currency that you have in hand.

Special currency conversion (for example, buying dollars for rubles) in order to buy dollar ETFs is fraught with additional costs. You will have to pay a commission for buying and selling currency on the exchange.

The same goes for selling. When you need money, after selling dollar ETFs, you will have to do a reverse currency conversion again. With new costs.

And with many brokers, exchange is carried out in lots, multiples of 1,000 CU. As a result, you will almost always have some funds left that will have nowhere to invest. And they will lie like a dead weight on the account.

Bought 1000 dollars for rubles. We purchased almost all ETFs. There will be a few dollars left that are not enough to buy one more share of the fund. Not scary. After a while, you decide to take profits and sell all dollar ETFs. From the initial investment of one thousand, the capital increased to $1,500.

1000 can be easily exchanged on the foreign exchange exchange. But what to do with the remaining amount?

There is no difference in terms of future returns. Will you buy ETFs in rubles or dollars?

ETF quotes are linked to assets (securities). And the exchange rate. As the dollar rises, ruble ETFs will automatically rise in price. And vice versa.

Step-by-step instructions for investing in index funds

I give instructions for dummies on investing in index funds. We will talk about purchasing ETF shares and shares of mutual investment funds on the Moscow Exchange.

Opening a brokerage account

To purchase shares and shares on the stock exchange, you need an intermediary - a broker. It provides access to the stock market and, on behalf of the investor, carries out transactions for the purchase or sale of securities. For operations on the stock exchange, an agreement for brokerage and depository services is concluded, a brokerage account is opened, where the money will be received.

The first step on the investment path is choosing a broker. Main criteria:

reliability - the license is checked on the Central Bank website and the rating on the Moscow Exchange;
terms of service - commissions, trading platforms, restrictions on deposits and withdrawals of funds, etc.;
ease of use – online account opening, mobile application, computer application, office at the client’s place of residence, etc.

After choosing a broker, all that remains is to open a brokerage account. The application is submitted online. The only documents you will need are a passport; TIN and SNILS are less often requested. As a rule, the account will be opened the next day and you can start investing.

Analysis of ETFs and mutual funds

Passive investing through index funds requires minimal time. But a basic analysis of ETFs and mutual funds needs to be carried out. Let's look at the main parameters that you should pay attention to when choosing a specific instrument for your portfolio.

Underlying asset

The underlying asset may be an index followed by a fund or a foreign ETF. In the second case, it turns out that the management company buys a ready-made ETF and takes its own commission for this, in addition to the ETF commission. It is better to look at information about the underlying asset in the table prepared by the Moscow Exchange.

Issuer

There are only 2 ETF management companies in Russia: FinEx and ITI Funds. For BPIFs – 11 (at the end of 2022). It is necessary to pay attention to the history of the management company and the level of control over its activities. For example, FinEx is monitored by the Central Bank of Ireland, the European Securities and Markets Commission, the UK Financial Conduct Authority and the Central Bank of Russia.

Below I have posted a current picture from my teacher Sergei Spirin about all the management companies that are currently listed on the Moscow Exchange.

Tracking Error

This is a parameter that determines how closely the fund follows the index. The lower the value, the better. FinEx must indicate this parameter in the description of its funds. BPIFs are not indicated.

Profitability

The first ETF in Russia appeared in 2013. This is a decent period to evaluate its profitability. BPIFs launched on the market only in 2018, so it is difficult to judge their effectiveness. But it is always possible to estimate the return of the index followed by the fund over a multi-year period. This is where tracking error plays a key role.

Commissions

This is one of the most important criteria when choosing. Look at this interesting table of the impact of costs on investor profits. Foreign ETFs are much more attractive than Russian ones, because their commissions are tens of times lower.

Analysis of an index fund using the example of the US Dividend Aristocrats mutual fund

As an example, let’s analyze the new mutual fund from Finam Management “Dividend Aristocrats USA” (FMUS). It entered the stock exchange on 02/08/2021. Management Company Finam Management is part of the largest investment company Finam, all necessary documents and licenses are available. FMUS is the first exchange instrument for it.

The fund follows the Dow Jones US Dividend 100 index. But it invests money not directly, but through a ready-made ETF - the Schwab US Dividend Equity ETF. The stock includes shares of 100 large American companies that have been paying and increasing dividends for 10 years or more. Among them are ExxonMobil, Texas Instruments Incorporated, PepsiCo, BlackRock, The Coca-Cola Company, International Business Machines Corporation (IBM), etc.

Over the past year, American ETF shares have brought investors 16% per annum, the average return over the past 5 years is 21% per annum. The Schwab US Dividend Equity ETF pays its holders 3% per annum in dividends. The Finam fund reinvests them.

Expenses at the time of writing were 6.51%. But literally a few weeks after the fund went public on the stock exchange, they were revised downwards significantly:

Schwab US Dividend Equity ETF management fee – 0.06% per year;
management remuneration – up to 0.7%;
remuneration to the depositary, registrar and exchange – up to 0.25%;
other expenses – up to 0.15%.

The total is 1.16% of the net asset value. Compare with the 0.06% commission for the ETF whose shares are purchased by Finam Management. My conclusion is clear: with a commission of 6.51%, FMUS will definitely not be in my portfolio. But in the new situation, those investors who do not have accounts with a foreign broker and qualifying status to enter foreign exchanges can already take a closer look at purchasing it. The commission is still quite high, but not as crazy as in the first option.

Portfolio formation

At this stage, the long-term investor must determine the structure of his investment portfolio. It will depend on the risk profile, financial goals and timing for achieving them. The main principle that must be observed is diversification. And this is best accomplished with the help of index funds.

I will again turn to Sergei Spirin and his classification of all funds on the Moscow Exchange by type of asset.

As an example (but not an investment recommendation), I will give my dad's portfolio. According to his risk profile, he is more of an aggressive than a conservative investor, but his age of 67 years does not allow him to invest in assets with high potential returns and risk. We put together the following portfolio:

FXRU – Eurobonds of Russian issuers;
FXRB – Eurobonds of Russian issuers with ruble hedge;
FXUS – shares of American companies;
FXIT – shares of American IT companies;
FXCN – shares of Chinese companies;
FXRL – shares of Russian issuers.

The distribution was conservative: 60% went to bonds, 40% to stocks. Dad did not want to include a protective asset in the form of a gold fund. For the year, the portfolio's return was 27%. Dad is happy. Plus, he will also receive a 13% income tax refund from the IIS.

And one more example. This is already my daughter's briefcase. She is 19 years old and has a long-term financial goal (minimum 10 years). It included not only funds, but also shares of individual issuers. But the portfolio is based on ETFs, including a protective asset in the form of gold FXGD:

international market shares (FXUS, FXIT, FXCN, FXDE) – 30%;
shares of the Russian market (FXRL and shares of individual issuers) – 40%;
bonds (FXRU, FXRB) – 25%;
gold (FXGD) – 5%.

The portfolio is more aggressive. 70% was allocated to stocks, but my daughter’s age and long-term goal make it possible to do this. Profitability over the last year is 22%.

Purchasing shares or fund units

This is the easiest stage of investing. When the strategy is determined and the funds in the portfolio are selected, all that remains is to buy shares or shares. To do this, you need to give a purchase order to your broker. Each of them has different trading terminals, so first study the interface and carefully fill out the required fields to submit an application.

ETFs and mutual funds are traded in T+2 mode. This means that you will become the owner of the purchased shares and shares 2 days after the actual transaction.