Exchange Traded Funds (ETFs) explained: Benefits, Risks and how they fit your investment portfolio
Exchange Traded Funds – commonly called ETFs – have become one of the fastest-growing investment options available to Australian investors. Yet despite their popularity, many people invest in ETFs without fully understanding how they work or when they are appropriate.
ETFs can be low-cost, flexible and easy to access, but they are still investments that carry risk. Before adding them to your portfolio, it is important to understand both their advantages and their limitations.
What Is an ETF?
An Exchange Traded Fund is essentially a managed investment fund that trades on the share market.
Instead of buying units directly from a fund manager like a traditional managed fund, you buy ETF units on the Australian Securities Exchange (ASX), just as you would buy BHP or Commonwealth Bank shares.
This means an ETF combines features of two investment types:
- Shares: you can buy and sell throughout the trading day
- Managed funds: your money is pooled and invested across many assets
When you invest, you do not directly own the underlying shares or assets. Instead, you own units in the fund, and the value of those units rises or falls depending on the performance of the investments held inside the ETF.
Australian ETF investment has grown rapidly. Within just two decades of their introduction to the ASX, ETF assets exceeded $100 billion – showing how widely accepted they have become among investors and advisers.
Types of ETFs in Australia
- Physical ETFs
Physical ETFs directly hold the underlying assets. For example, a share-market ETF may hold hundreds of Australian or international companies.
These are the most common ETFs and are generally easier to understand.
- Synthetic ETFs
Synthetic ETFs use derivatives (financial contracts) to produce investment returns instead of directly owning all the underlying assets.
Because derivatives add complexity and counterparty risk, synthetic ETFs typically carry higher risk than physical ETFs and require careful understanding before investing.
- Hybrid ETFs
Hybrid ETFs broaden the concept further. In addition to trading on the stock exchange, investors may also apply directly with the fund manager using application forms in the product disclosure statement. They can also provide access to a wider range of strategies and asset classes beyond traditional index tracking.
How ETFs Work
Most traditional (“classical”) ETFs aim to track an index rather than outperform it. For example, an Australian share ETF may simply replicate the ASX 200 index.
As the index rises or falls, the ETF value moves similarly. This approach is known as passive investing.
Because the fund manager is not actively selecting individual shares, costs are usually lower than actively managed funds.
Why Investors Use ETFs
- Diversification
With a single purchase, an ETF can provide exposure to hundreds or even thousands of investments, including:
- Australian shares
- international shares
- property securities
- fixed interest assets
- specific sectors (such as technology or healthcare)
This diversification reduces the risk associated with holding only a few individual shares.
- Liquidity and Flexibility
You can buy or sell ETFs on any trading day. This allows you to:
- gradually build an investment
- sell if cash is required
- rebalance your portfolio easily
- Lower Costs
ETFs typically have lower management fees than traditional managed funds. However, investors still need to account for:
- brokerage fees when trading
- management expense ratios inside the fund
The Risks Investors Should Understand
Although ETFs are simple to access, they are not risk-free.
Market Risk
Because ETFs track markets, they will fall when markets fall. Unlike a bank account, your capital is not guaranteed.
Tracking Risk
ETFs aim to replicate an index, not protect you from volatility. If the index declines 20%, your ETF will likely do the same.
Complexity Risk
Synthetic ETFs and some specialised ETFs (such as leveraged or niche sector funds) can be significantly more volatile and may not suit conservative investors.
Tax Considerations
ETFs generate income distributions and capital gains. When you sell units, Capital Gains Tax (CGT) may apply and can be significant depending on the holding period.
Care is also needed when investing on behalf of children – accounts held by an adult trustee may result in the adult being taxed on the income.
ETFs vs Managed Funds
While ETFs share similarities with managed funds, there are key differences:
| ETF | Traditional Managed Fund |
| Trades on ASX | Purchased through fund manager |
| Intraday pricing | Priced once daily |
| Usually passive | Often actively managed |
| Lower fees generally | Higher fees typically |
Interestingly, ETFs are actually a type of listed managed fund – simply structured differently.
Are ETFs Suitable for You?
ETFs are often well suited to:
- long-term investors
- superannuation portfolios
- SMSFs
- diversified portfolio construction
However, suitability depends on:
- your risk tolerance
- investment timeframe
- income needs
- tax position
Investors should understand the expected returns and potential volatility before committing funds. Importantly, ETFs should form part of a broader investment strategy – not the entire strategy.
Final Thoughts
Exchange Traded Funds have transformed investing by making diversified portfolios accessible and cost-effective. They allow everyday investors to access global markets that were once available only to large institutions.
However, simplicity of access does not mean simplicity of outcome. ETFs still carry market risk, tax implications and structural differences that need to be understood.
Used correctly, ETFs can play a valuable role in a well-designed financial plan. Used without proper guidance, they can expose investors to unexpected risks.
If you are considering ETFs – or already hold them – a review can help ensure they align with your overall financial goals, timeframe and risk tolerance. Professional advice can help you select appropriate investments and integrate them effectively into your portfolio strategy.
Seeking advice certainty
The advice team at Continuum Financial Planners has accumulated valuable experience in the use of the ETF asset class in investment portfolios. They can help you take the appropriate action when incorporating ETFs into your portfolio. To arrange a meeting with one of the team –
- phone our office, on 07 3421 3456, or
- at your convenience, use the linked Book A Meeting
(This article was first posted by us in February 2026.)