How do ETFs help spread my investment risk?

Author: By Tom Sieber

Spreading your investment risk is mainly down to doing one thing – diversification. If you’ve invested the majority of your cash into a few select companies or just one particular sector or asset class then any upsets to those companies or sectors will have a pretty painful impact on your investments

By investing in different areas you spread the load and reduce the risk of making a loss on your money if the markets take a turn for the worse.

The difficulty for many individual investors, particularly new or less experienced investors, is they do not have the money, time or expertise to construct their own diversified portfolio made up of tens or even hundreds of individual holdings.

Exchange-traded funds (ETFs) provide a quick and low-cost solution to this problem. There are almost 1,200 ETFs listed on the London Stock Exchange and between them they provide exposure to a wide range of different markets.

An appropriate example of this is the MSCI ACWI (All-Country World Index) ETF. The name might sound a little intimidating for someone new to investing but don’t let that put you off - this ETF essentially tracks the performance of stocks from 23 developed and 23 emerging markets countries, containing 2,476 different assets and covering roughly 85% of the global investable equity universe. By buying into this ETF you will have globally diversified yourself with just a single investment and for one low-cost price.

Many people use ETFs to track the performance of certain stock markets or indices. However, this means your investments will always be at the mercy of the performance of stock markets and could leave you open to risk in the event of a crash.

In the last ten years an increasing number of markets began to move in unison, going up when there are positive developments and retreating on bad news. This makes it more difficult for investors to achieve true diversification away from the performance of the stock markets – particularly if investing purely in stocks and shares.

This has led to a search for assets whose returns are not linked to the core financial stock markets. ETFs provide a way to access many different and diverse elements of market exposure. This can include areas such as commodities, infrastructure or property.

These assets would be very difficult for ordinary investors to access otherwise. Infrastructure, for example, requires lots of money up front and is not easy to buy or sell. ETFs lower the barrier for entry by offering low-cost and transparent exposure to this theme.