Are you really buying an ETF or just trading a CFD?

Have you ever wondered if you’re actually buying an ETF (or another “real” asset) in your brokerage account, or if you’re merely gaining exposure to its daily price movements through a CFD? Many investors aren’t fully aware of the difference between acquiring a Contract for Difference (CFD) and buying a “real” product like an ETF.

In this article, we’ll explore the main distinctions between these two financial instruments to help you make more informed decisions in the future.

What is an ETF?

An ETF (Exchange Traded Fund) is an investment fund traded on a stock exchange, combining the characteristics of a traditional mutual fund with the flexibility of individual stocks.

In simple terms, an ETF is a “basket” of assets (such as stocks, bonds, commodities, or other financial instruments) that you can buy and sell on a stock exchange just like you would with individual shares.

What is a CFD?

A CFD (Contract for Difference) is a financial instrument that reflects the price movement of an underlying asset (which can be a stock, currency pair, commodity, ETF, and more).

With a CFD:

• You do not own the underlying asset.
• You enter into a contract with your broker to pay (or receive) the difference in price between the opening and closing of the position.
• You can typically open and close CFD positions at any time.
• You may be forced to close your position if you don’t meet the minimum margin requirement due to leverage.

The risk of leverage

Leverage is one of the main risks when investing in CFDs. By using leverage, you borrow money from your broker to open a larger position than your cash deposit (margin) would otherwise allow. If the market moves against you, losses can mount quickly. Under Negative Balance Protection rules imposed by the European Securities and Markets Authority (ESMA) since August 2018, losses in a regulated EU account cannot exceed the funds you have on deposit. However, you can still lose your entire margin.

Example:

• Suppose Microsoft shares are trading at $150, and you believe the price will rise. You want to buy 1,000 Microsoft CFDs.
• Under European regulation, share CFDs have a maximum leverage of 5:1 (meaning a 20% margin).
• Total position value: $150 × 1,000 = $150,000.
• Required margin (20%): $30,000.

If the share price moves against you, your potential losses could exceed $30,000 in theory, but ESMA’s Negative Balance Protection ensures you won’t lose more than the total amount on deposit in your CFD account (in this case, $30,000).

How can you tell if you’re buying an ETF or a CFD?

On broker platforms that offer CFDs, there’s typically a separate section labeled “CFD.” Look for any mention of “CFD” when selecting an asset.

For instance, if you search “Microsoft” at a broker like XTB, you’ll usually see two options: one for the Real Stock (often labeled “Share”) and one for the CFD version.

If you select "CFD", and click the "information" button, you will quickly notice that, as we said previously, there is a margin of 20% of the total amount invested:

Additional costs when trading CFDs

Besides the standard commissions, spreads, and possible currency conversion fees, CFDs usually incur overnight financing costs (also known as “swap fees”) because you’re effectively borrowing money from the broker to hold a leveraged position.

Example of a swap fee calculation:

• Underlying Asset: Microsoft Stock (CFD)
• Position: Long (Buy)
• Position Size: 10 CFDs (equivalent to 10 shares)
• Share Price: $150 (hypothetical)
• Daily Long Swap Rate: -0.02464%

Position Value = 10 × $150 = $1,500
Daily Swap = $1,500 × (-0.02464%) = -$0.3696 per day

You’d be charged roughly $0.37 for each day the position remains open (actual rates vary by broker, underlying asset, and market conditions).

Using XTB as a reference, you can see that the “daily swap long rate” is -0.02464%:

Quick comparison: CFD vs. ETF

If there’s one key takeaway, remember:‍

• ‍With CFDs, you are not the beneficial owner of the asset, and you typically use leverage.‍
• With ETFs, you actually own shares in the fund - similar to owning personal property like a bike or car.

Final thoughts

CFDs and ETFs can both play a role in an investment strategy, but it’s crucial to understand their fundamental differences before you commit your money.

• CFDs offer flexibility, the ability to go long or short, and leverage that can amplify both gains and losses.
• ETFs provide a diversified basket of assets and are usually more suitable for long-term investors who want real ownership of the underlying assets.

Ready to learn more about smart investing in Europe?

‍Check out our other articles on EUPersonalfinance.eu to stay informed and confident in your personal finance journey. Remember: knowledge is power - especially when it comes to safeguarding your hard-earned money.

_{Disclaimer: This article is for informational purposes only and does not constitute financial or investment advice. Always do your own research and assess the risks involved before making any investment decision.}