Why is everyone getting on board the ETF wagon?

You may not have heard of exchange-traded funds (ETFs) just yet, but their soaring popularity means you soon will.

By definition, an ETF is a type of investment fund that tracks an index, sector, commodity or other asset.

They are similar to mutual funds, but just like shares, ETFs can be bought or sold on a stock exchange.

There are currently more than 230 ETFs listed on the ASX.

ETFs are low cost and easy to use, which sums up why they have been a hit with investors.

They have low ongoing fees, about 0.1 per cent, because they don’t come with investment managers making active investment decisions.

ETFs are available across a range of asset classes and individual assets including Australian shares, international shares, bonds, commodities and foreign currencies.

To buy or sell an ETF, you need a trading account with a stockbroker or investment platform such as eToro.

ETFs are a great tool for diversifying your portfolio. Photo: Getty

When you buy an ETF, it’s important to know you don’t own the underlying investments.

Investors only own units in the ETF and the ETF provider owns the shares or assets.

Instead of trying to outperform the market, ETFs are generally used as long-term investment tools to accumulate steady yields, said Josh Gilbert, eToro market analyst.

“ETFs are often built to track a benchmarking index, such as the S&P500 or the Dow Jones,” he explained.

“Therefore, ETFs are unlikely to outperform the market. If you’re looking to outperform the markets, investors are usually better off investing in individual equities.

“Each ETF will have a history of its performance over the years.

“Be sure to check this before investing so that you can gauge what to expect moving forward. Past performance isn’t a guide to future performance, but it will allow you insight into how the ETF has performed.”

ETFs are also a great tool for diversifying your portfolio.

Through one security, you can potentially have exposure to hundreds of different individual stocks. You can also diversify across a number of different ETFs to reduce your risk of loss if one ETF provider collapses.

ETFs are available across entire sectors, such as technology and healthcare sectors, so investors don’t have to pick one or two specific stocks.

Fans of ETFs also like the transparency of investing.

This is thanks to the ETFs publishing the net asset value (NAV) daily, which allows investors to track the performance of the underlying asset.

And unlike some other investments, ETFs are easily traded because you can buy and sell them during the trading hours of the exchange.

To learn more about ETFs visit eToro.