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ETF

ETF FOR DUMMIES

2: ”😅👍🏻 I admit, I don’t read a lot on your blog”
1: ”your mistake 😂”
2: ”Most of the time I don’t understand what it says anyway🤷🏻‍♂️”
1: ”Not even you can be this dumb”
3: ”😂😂😂”

I write too complicatedly

What starts in a funny, yet somewhat sad way, was a discussion on my article about my ETF dividend strategy and my blog as a whole. A damning verdict from a good friend, the inventor of the mnemonic “netto = not so much, brutto = brutally plenty” (it's more fun in german). As things go, the group chat escalated, and I had to admit to myself that I don’t write as understandably as I had always assumed.

Of course, I could go into the different examples I was presented with, however, I just decided to write about ETFs in a foolproof way instead. This, because in my opinion they are still one of the best existing investment instruments.

ETF-FOR-DUMMIES-FinanzFabio

What is an ETF

Imagine that you decided not only to accumulate your money in your savings account, but also - even worse - on your payroll account. No, instead you want your money to work for you. Earning money sleeping, so to speak.

Passive income

Earning money in your sleep is referred to as passive income. You work for it once, and then you earn more money from it automatically.

Renting out apartments

An easy example of this would be: You buy an apartment (buying being the work in this case) and you rent it out. The rental revenue is your passive income, which reaches your account every month, even if you only lie in bed sleeping.

Dividends from ETFs and stocks

Renting out apartments is not the only way of building passive income.

You can also buy stocks once (work) and earn money regularly through the dividends (passive income). Dividends are basically interest which you receive from a company because you invested money into it. Similar to back in the day, when you would receive interest on the money in your savings account. Remember? That was roughly a thousand years ago.

With your invested money the company can then arrange further investments and in turn make more profits. From those profits they return a portion back to you, in the form of a dividend. Regularly can mean once a year, quarterly, or with a few companies even on a monthly basis. If the company had a fantastic year, it may well be the case that they pay you a special dividend, so, a higher interest than usual.

Dividend payments are not a must, however. If business is slow, the company may reduce dividends, or even cut them completely.

Not all your eggs in one basket

When it comes to investing money into stocks you should buy more than just one type of stock. Imagine your whole money, let’s say CHF 10’000, would have been invested in Swissair stocks back in the day. When the flight company went bust and filed for bankruptcy, all their stocks lost their value. Your CHF 10’000 would have vanished into thin air. A total write-off.

Diversification

Buying stocks from different companies is much smarter. In technical terms we call this “diversification”. Diversification means taking your CHF 10’000 and investing it into several types of stocks. A smart person once said that you have to buy a minimum of 20 different shares in order to be diversified sufficiently. In this case every stock has a relative worth of 5%, which translates to CHF 500. If Swissair goes bust now, you only lose CHF 500 instead of your complete CHF 10’000.

But diversification can go even further. Instead of investing in different companies, you can also invest in different countries, in multiple economic sectors, several currencies, and more.

ETF save you work

Admittedly, picking 20 different shares is not easy, especially not as a beginner.

But you and I, we want to invest our money as easily as possible. So, we buy ETFs instead of shares.

An ETF automatically invests in many different companies. These companies are first determined through an “index”. Generally also in many more than just 20 businesses (the SMI for example invests in exactly 20 businesses, the 20 biggest in Switzerland). It can be hundreds (S&P, over 500 companies), sometimes even thousands (MSCI World, 1280 companies) of companies, which are represented in an ETF. A higher degree of diversification is hardly possible.

Some ETFs invest exclusively in Switzerland, some in other individual countries, others in Europe as a whole, the USA, Asia, or even worldwide.

ETFs are inexpensive

And with inexpensive I mean dirt cheap. The running annual costs of an ETF are most often shortened to “TER”. It is not rare to find an ETF with a TER, i.e. cost, of 0.04% - and no, this is not a typo, they really are that inexpensive. Of course, there are also more expensive ones. Personally, I would not buy an ETF more expensive than 0.49%.

There is a simple reason why ETFs are so inexpensive, as they are not actively maintained by a human fund manager. Because humans always want a salary for their work, an ETF is less expensive than an actively managed fund.

What you have to add to the running cost are the fees for buying and selling. So called order fees. This is why it is worth investing larger sums at once. Personally, I always buy ETFs for a minimum of CHF 1’500 from Swissquote.

ETFs are boring and profitable

An ETF is not only diversified, but also profitable. However, that does not mean that you buy an ETF today and are rich by tomorrow. No, for an ETF you need patience. A lot of patience. I am talking decades. ETFs are really boring and not sexy at all. But what would you rather be, sexy or rich? In a lot of years, so decades, you will be rich.

Why are they profitable? On the stock market perseverance and compound interest pay off. If you continuously buy and sell shares you have to pay fees every time. An ETF just tenaciously stays faithful to its index. As long as the index does not change companies, the ETF won’t either.

Summary of the advantages of an ETF

  • An ETF is broadly diversified and spreads its risk
  • An ETF is passive and thus inexpensive
  • An ETF is profitable and builds up compound interest

Opening a trading account

You need to have a broker in order to buy an ETF. On the broker’s platform you can view the current stock market prices and what an ETF currently costs. The prices are basically in real time.

As with everything, with brokers you also have cheap and expensive options. The cheaper brokers are mainly found abroad. Germany has many providers, which are also popular in Switzerland. I personally prefer having my money in Switzerland, therefore Swissquote is the broker of my choice. Signing up requires some patience and you need a few documents in order to open an account.

Other things you need to know about ETFs

Now you know how an ETF works and what its advantages are, how you can open a trading account, and how high its running costs are. Once you engage with the topic in more depth, you will encounter the following two terms.

Accumulating

An accumulating ETF does not continuously pay out dividends to you. Quite the contrary, it reinvests the dividends into itself, buying more shares for you. The reinvestment happens automatically and allows you to maximise compound interest. If you do not want to further have to worry about an ETF after buying it, an accumulating ETF is your best choice.

Distributing

The opposite of an accumulating ETF is a distributing ETF. The dividends are not automatically reinvested, but they are directly paid out to your broker’s account. What you do with that sum afterwards is your business. You can keep it in your account or pay your Netflix subscription with it every month. This way you don’t really profit off of compound interest.

Personally, I am a big fan of distributing dividends. Seeing how much money I actually earn this way every month truly motivates me to invest. For me it’s a purely psychological effect.

Taxes

Of course, taxes also have to ruin the fun with something as cool as ETFs. And this is how you are taxed in Switzerland:

Taxes on capital gain

If your ETF makes profits on the stock exchange it is called capital gain. Profits here do not refer to dividends, but to the ETF becoming more expensive throughout the years.

Example: You buy an ETF for CHF 30 today. 20 years from now the worth of the ETF, or its price, has risen to CHF 116.10. The difference of CHF 86.09 is your capital gain. You are not taxed for this in Switzerland, which makes ETFs, and by the way also individual shares, extremely attractive.

Taxes on dividends

Dividends are subject to income tax. Income tax is paid on the money you earn. Like the salary you receive from your employer, dividends are taxed at the end of the year.

In Switzerland it does not matter if your dividends are paid out or reinvested. You pay income tax on it either way.

In addition, the dividends are charged with a withholding tax, which will be returned to you after a year. The withholding tax is therefore negligible.

That’s already it for the basics of ETFs

Alright, that was it. If you understood this post and want to go into more depth on ETFs and dividends, then I want to recommend my article on my ETF-dividend strategy. There I go over my personal strategy and the know-how you got from this article is fundamental in understanding that.

If you want to support my blog and have been bit by the investment-bug, then use my discount code at Swissquote:

MKT_FINANZFABIO

See you soon,

FinanzFabio

Portrait von Fabio

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