What if you can have an investment that combines the advantage of mutual fund and UITF and the power of stock trading? It is now possible with exchange traded fund, a relatively new way to earn passive income.
What is an exchange traded fund?
An exchange traded fund is like a mutual funds (MF) or a unit investment trust fund. It is an investment company that buy shares of companies like PLDT, Jollibee, Aboitiz, SM, Ayala, etc. It is valued according to the worth of all the shares it holds, and its total value is divided into stocks that are traded on the stock exchange. People can then buy these ETF stocks to invest.
ETF vs mutual funds vs UITF
Stated in another way, the ETF is structured the same way as mutual fund and UITF. The difference is the way people invest in them. In mutual funds, people invest by buying from the mutual fund company and UITF from banks or trust entities.
On the other hand, ETF investors buy stocks on the Philippine Stock Exchange. That is, it acts like a stock that can be traded.
Another difference is the way you can get your money back. In mutual fund, you redeem your shares from the MF company and in UITF, you redeem your units from the bank/trust. Both of these companies are obliged to buy them back from you and release your money that is equivalent whatever is the value of your investments.
In ETF, you simply sell your stocks on the stock market and wait for a buyer to purchase them.
Below is a table that sums up the characteristics of each fund.
|Manager||Mutual fund company||Banks and trust||Investment company|
|Initial||P50 – P5,000||P50 – P5,000||Depends on price and board lot|
|Add||P50 – P1,000||P500-1,000||Depends on price and board lot|
|Purchase||NAVPS||NAVPU||Intraday market price|
|Costs||Sales load, back-end load, exit fee||Exit fee||Stock trading fees|
|Dividends||None||None||May be distributed|
So why ETF?
An exchange traded fund was created in the past as a vehicle that carries a basket of stocks. It offers a convenient way in trading because just by buying one stock, you indirectly get to own many shares of large companies.
While this is also true with MF and UITF, the difference is that you don’t need to wait until the end of the day like what you do with determining the value of an MF stock or a UITF unit. The price of the ETF stock is reflected real-time.
How does ETF work?
So let’s answer the question, what are the features of the ETF?
The investment company offers ETF. In the Philippines, the First Metro Investment Corporation (FMIC), a subsidiary of Metrobank Group, launched the country’s first ETF, the First metro Philippine Equity Exchange-Traded Fund (FMETF).
The ETF is regulated by the Securities and Exchange Commission and the Philippine Stock Exchange.
It is usually generally passive in management; meaning, its goal is usually just to match a benchmark. The FMETF for example simply follows the stock index, which is made up of the top 30 companies in the Philippines.
Managing the fund costs money, so the company passes that on to investors in the form of fees. These fees are structured into the price of each ETF stock. According to the Philippine Stock Exchange, the management fee of the FMETF is 50 basis points (0.50%) per year of the net asset value of the fund.
Purchasing and selling the ETF stock is done on the Philippine Stock Exchange. The local stock exchange is open usually on weekdays except weekends and holidays between 9:30 in the morning until 3:30pm with lunch break.
Just like being a shareholder, once you are an investor, you may be entitled to receive dividends. This is possible when the ETF decides to distribute capital gains instead of putting them back to the business.
How do you invest in ETF?
So how do you get started investing in exchange traded fund? There are three things that you need to do.
- Prepare minimum investment
- Open an account with a stock broker.
- Start trading.
There is actually no pre-declared minimum investmetn. Instead, the least number of stocks you can buy would depend on the price and the minimum board lot as stated by the Philippine Stock Exchange. As you can see from the table below, when the price of a stock is between ₱100 to ₱199.99, then the minimum number of shares upon buying is 10 stocks.
Next, you need to open an account with a stock broker like COL Financials, UTRADE, or First Metro Securities Inc. The broker is going to execute your request to trade. They might ask you to fill out some forms and put up a starting investment to put up.
Learning their trading platform might take some time and familiarity, but you should be able to find FMETF, the ticker symbol for First Metro Exchange Traded Fund.
Start trading ETF stocks
You can now already start trading. Again, check the board lot and buy at the the bid price you’re comfortable with.
Also, bear in mind that each time you make a transaction, either acquiring shares or selling them, you will be charged the following fees:
- broker’s commission
- value added tax of the commission
- Philippine Stock Exchange transaction fee
- Securities Clearing Corporation of The Philippines fee
- sales tax
How is the price determined?
Any ETF has two prices:
- its net asset value per share
- market price
The net asset value per share (NAVPS) is computed by adding up all its assets minus liabilities divided by all outstanding shares. It publishes the NAVPS real-time as a guide to investors when acquiring shares on the stock exchange.
At the same time, ETF is subject to the same supply-demand forces that affect stocks in general. Its price is determined by the market. The more people buy it, the higher the price goes. If there are fewer, it goes down.
When there is a disparity between NAVPS and the market price, the company generally intervenes to make the market price closer to the NAVPS. This is called ETF arbitrage. If the market price goes up, it sells ETF stocks and uses the money to buy more underlying assets. In doing so, it drives the price down.
If the price goes down then it sells underlying assets to buy more ETF stocks, bringing the prices up.
Benefits of exchange traded fund
The advantages of ETF are the following:
- There are no sales load or front-end fees.
- Stock price is reflected real-time during trading hours.
- It’s transparent. The list of underlying assets is published and updated periodically.
- Opening an account is easy.
- With just one ETF stock, you get to be part of the earning potential of large companies. The fund gives you diversified portfolio.
- It’s more convenient and cost-efficient than managing your own portfolio of individual stocks.
- Management fees are generally lower than MF and UITF.
- You can buy or sell stocks any time, any day for as long as the stock market is open.
- The only way to invest is through a broker.
- There’s limited control on what companies the fund invests.
- You can only redeem your investment when someone else buys your stocks.
- Buying or selling stocks trading fees.
- Initial investment required depends on the stock price and the minimum board lot.
- When ETF distributes capital gains in the form of dividends, earnings are subject to tax.
- Because it is traded, its price might be overvalued with respect to the worth of its portfolio.
How do you redeem investment?
When you want to get your money back, all you have to do is sell your shares. You get your investment once you a buyer is willing to purchase them at a price that you set. The exchange of shares between you and the buyer all happen on the stock market.
How do you know your earnings?
So how do you determine if you’ve gained or not? What is one way to compute your earnings? The trading platform of your broker must be able to tell you at a glance your (un) realized profit or loss.
However, if you want to know and do the math by yourself, then you can deduct the price you sold the stocks from the price when you bought it and then multiply the result with the number of shares.
Before you invest in ETF
If this is the first time to invest, here are the things that you should do before you jump in.
- Write down your financial goal and tie it with your investment. In this way, it’s attached to a personal purpose and you avoid doing it for the sake of investing.
- Check the ETF that is available in the market today. See if it matches with what you’re looking for.
- If it isn’t, here are other easy passive income you can learn about.
- Make sure that you learn about the risks associated with the fund. Is it volatile? If so, how would you react when prices go down?