Generating passive income through ETF’s can be a very easy source of income. Read through the information below to find out how!
What are ETF’s?
Exchange Traded Funds or ETF’s for short are publicly listed funds that are under management which generally aim to follow a specific benchmark or index. They came about in 1993 in Canada due to institutionalized investors undergoing some advanced trading techniques and strategies. Once the individual investors found out about ETF’s and how institutionalized investors were using them, they took the over all concept and tweaked them into the modern ETF.
What was the first ETF?
The first ETF in the modern era was from Toronto 35 Index Participation or TIP which allowed investors to have exposure to the top 35 companies on the TSX (Toronto Stock Exchange) without going out an investing in each individual company on the TSX. Now this was a big deal back in 1993. The popularity of the TIP grew as investors saw the benefits that the exposure offered and investors flocked. This then opened up opportunities for other ETF’s within the TSX and other markets including the NSYE, FTSE etc. By the end of 2017 the number of ETF’s on the TSX was 648. This can be compared with similar growth in other markets with NSYE offering 1,707 ETF’s by 2016.
Back in 1993 the TIP35 absolutely flipped the mutual fund market that had predominantly had the market share and no competition for alternative products. Don’t get me wrong there was plenty of mutual funds, but the ability to buy and sell the shares with such ease was an absolute game changer. Investors loved the idea to be able to buy Canadian blue chip stocks, with minimal management fees, transparent information and diversification – and that is exactly what they got.
So what happened to the TIP 35? Well it ended up be the forerunner for the iShares S&P/TSX 60 Index Fund that has a ticker code of XIU.TO.
How do ETF’s create passive income?
Well its pretty easy – an ETF will pay out a generally semi annual distribution to the unit holders. Once you get that initial unit holding, as long as the ETF remains on the market you will receive payouts twice a year until the day you die (and then even longer). Despite ETF’s short history so far, they are not going anywhere and you can bank on them staying around for hundreds of years. As an example say you purchased VAS.ASX an Australian Vanguard product that is designed to follow the ASX300 and you pick up at $79.00 AUD. Since it is opened in 2009 at $50.61 per unit it has grown to $79 over 10 years equaling $28.39 capital gain or 56% ~ 5.6% per year of growth. During this time it generally pays out a 4.6% dividend every year. Ignoring inflation and a few other factors you will receive 10% return per year that is a decent return if you ask me! So sit back and wait for the passive income to roll in the door each and every year while you do nothing. To get this process moving even faster continue reinvesting your distributions and continue to purchase more units in the ETF. 10-20 years down the track you will be thankful for the sacrifices you made in present time.
What cause premiums and discounts in ETF’s?
An ETF should be traded at the Net Asset Value (NAV) of the combined securities it owns; however there are some exceptions to that rule that create premiums and discounts. The exceptions to the rules come about from trading hours and market liquidity that misalign the NAV and the share price.
A premium comes about where the share price is higher than the NAV indicating that the ETF may not be a good purchase at that point in time.
A discount occurs when the share price is lower than the NAV indicating that the ETF may be a good purchase at that point in time.
Any short premium or discount will quickly change as the market conditions vary throughout a day and will only be available for a short period before potentially flipping to the opposite. Additionally an authorized participant can trade to keep the asset value in line with the share price.
What ETF to invest in Australia?
In Australia there are several ETF providers including:
– ANZ/ETF Securities
– Russell Investments
– State Street
– Van Eck Global
The most common ETF’s that Australian investors tend to go for are VAS.ASX IOZ.ASX and VGS.ASX. But these will change dependent on what you as the investor are after. The decision is up to the investor but if you look at VAS.ASX as a benchmark for performance, fee’s, yields etc this would be a good start, you can then factor in alternate ETF’s from there.
Can you reinvest dividends in an ETF?
Yes you can, once you purchase the shares you will get some information in the mail that will enable you to sign up to the dividend reinvestment plan (DRP). You can also sign up online through the share registry and make the change for the dividends or distributions to be reinvested.
If you want some more information on this – please go through to etfbloke.com for Australia related ETF information and advice.
Disclaimer – The information on this website is for general information purposes only. It is not intended as legal, financial or investment advice and should not be construed or relied on as such. Before making any commitment of a legal or financial nature you should seek advice from a qualified and registered legal practitioner or financial or investment adviser. No material contained within this website should be construed or relied upon as providing recommendations in relation to any legal or financial product.
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