A beginner’s guide to ETFs (Part 2)
In Part 1 of this guide, we covered what an Exchange Traded Fund (ETF) is, and what are the returns. Now, we look at the considerations behind choosing an ETF to invest in, the risks involved, and the account options you can tap on.
What should you consider before buying an ETF?
First and foremost, start with yourself. Consider your own needs, investment objectives, and risk appetite. Like a stock, the prices of ETFs fluctuate with demand and supply throughout the day. This implies an amount of volatility. If you’re not about to monitor the market or ready to carry the risk, then a lower-risk investment instrument would probably be more suitable for you.
Once you’ve decided you’re ready to invest in ETFs, and can explain in your own words how it works to your makan buddies, invest some time to go through ETF strategy reports to help you decide which ETF to buy. Past performance results provide some indication of growth prospects, but never base your investment decision solely on this.
Also, consider the different ETFs out there that you can buy. Understand the differences, each ETF’s prospect and any associated risks, before putting your money into it.
What are the risks involved?
One of the risks involved in investing in ETFs is market risk. You are exposed to the volatility of the specific underlying assets or market(s) the ETF tracks. This risk cannot be diversified and during adverse market conditions the ETF’s value will decline accordingly.
Another risk is tracking error, or the difference between the portfolio’s returns and the index it is meant to trace. This happens when the fund manager of the ETF is unable to perfectly replicate the performance of the index with the ETF tracks. The difference between the index and ETF returns are generally due to management fees, and timing differences.
When an ETF is priced in a different currency from the local currency, you would also be exposed to foreign exchange risk. This can potentially increase or erode the ETF’s returns.
As with most investment products, it is possible in certain situations that you can lose, or gain, a substantial amount of money.
Could I tap on my CPF account to invest in ETF?
If you’re wondering if it’s possible to use your retirement funds to buy ETFs, the good news is, you can. However, do note that you can only invest monies in excess of $20,000 and $40,000 in your Ordinary Account and Special Account respectively.
There are currently four SGX-listed ETFs you can purchase using your CPF:
- ABF Singapore Bond Index (A35 SP Equity)
- SPDR STI ETF (ES3 SP Equity)
- Nikko AM STI ETF (G3B SP Equity)
- SPDR Gold ETF (GLD US Equity)
If you have a Supplementary Retirement Scheme (SRS) account, you can also use the funds to buy most of the SGX-listed ETFs. One criteria is that you have to settle the transaction in Singapore dollars.
It is important to gain a comprehensive understanding of what you’re investing in and the associated risks before you dive in. Should you have any further questions, feel free to contact us.