Things to consider when picking an ETF
If you want to invest in an ETF, we'll show you how to pick a fund that's right for you.
ETFs, or exchange-traded funds, have become an increasingly popular option with Australian investors in recent years. And with the ASX Australian Investor Study 2020 revealing that 45% of investors aged 18-24 are planning to invest in ETFs in the next 12 months, it's a market that could continue to grow.
But with over 200 ASX-listed ETFs to choose from, and many more on overseas markets, how do you choose an ETF that suits your investment goals?
Let's take a closer look at the key factors you need to consider when deciding which ETF is the right destination for your hard-earned cash.
The underlying asset or index you want to track
The first thing you need to do is think about which markets or industries you want to target. Most ASX-listed ETFs are passive investments that try to track the performance of an underlying index or asset. For example, the fund may track the ASX 200 share market index or focus on a specific industry (such as technology stocks).
So think about whether you want to invest in Australian or international markets and whether there's a particular sector you want to target before you invest.
If you're looking to buy US-listed ETFs, you'll need to sign up with a broker that offers access to US stock exchanges, such as eToro. If you're interested in buying Australian-listed exchange-traded funds, you'll need to open an account with a broker that offers ASX stocks.
You can also find out more about how ETFs work in our beginner's guide to ETFs.
Your investment goals
Your investment goals and timeframe will play a huge role in determining the ETF you choose. It all depends on your financial needs and your appetite for risk, so it's important to have a clear picture of how much you want to invest and what you want to achieve.
Many ETFs are relatively low-risk investment vehicles, designed to offer steady long-term growth. But active ETFs, which are sometimes referred to as exchange-traded managed funds (ETMFs), aim to outperform the market or a specific index. They offer the potential for higher returns, but come with a higher level of risk attached.
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The importance of diversifying
Diversification is an important consideration for any investor. By not putting all your eggs in one basket, you can reduce your risk.
ETFs that invest in indexes like the ASX 200 or the S&P 500 offer diversification right from the get-go as your money is spread across a wide range of sectors and companies.
But those funds that target individual sectors are inherently a little less diversified. If you're investing in one of these ETFs, you may want to look for a fund that provides exposure to a variety of industries across a range of international markets.
You'll also need to consider your existing investment portfolio, if you have one, when choosing an ETF. If all of your money is currently invested in Australian shares, you may want to consider an ETF that provides exposure to international markets or other asset classes.
Do your research and check the fund manager's breakdown of the ETF's holdings so you know exactly where you'll be investing your money.
Who is the fund manager?
Next, consider the firm behind the ETF. Is the fund manager a reputable provider with a long history in the industry? How long have they been managing ETFs and what sort of track record do they have?
Vanguard, BetaShares and iShares (BlackRock Investment Management) are a few of the most recognisable names, but there are several other well-known providers to choose from.
Now we come to the factor that will be at the forefront of every investor's mind: cost. When you choose an ETF, you'll need to take into account the management fee (MER fee) that applies.
This annual fee is taken out of your investment returns, and it's separate from the brokerage fee you pay to your online share trading platform when you buy or sell ETF units. However, the fee amount varies depending on factors like the index and market being tracked as well as the provider that manages the fund.
A lower management fee doesn't necessarily mean that one fund is better than another, but even a seemingly minor variation in fees can make a big difference to your overall returns.
Many ETF management fees fall in the 0.2-1% range, but some funds charge lower or higher amounts than this. Check the PDS and the terms and conditions before you invest, and find out more about ETF fees in our guide to the cheapest ETFs on the ASX.
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The size of the fund
Another factor you should consider is the size of the ETF. ETFs with more funds under management and larger daily trading volumes will generally be easier to buy and sell quickly and efficiently, with tighter buy/sell spreads than smaller funds. Many commentators also point to the fact that larger funds can take advantage of economies of scale, allowing them to charge lower management fees.
That said, choosing a larger fund doesn't necessarily equate to better investment returns, so size is far from the only thing that matters when choosing an ETF.
What about past performance?
Research the track record of a fund to find out what sort of returns it has delivered to investors in previous years. Our guide to the best-performing ETFs in Australia is a handy starting point to help you compare leading funds over the past one, three and five years.
But as always, remember that past performance is no guarantee of future performance. Just because a fund has outperformed all others over the past five years doesn't mean it'll deliver the same level of returns in the next half-decade.
Just like choosing any other investment, picking an ETF isn't something you just do on a whim. Make sure you have a clear picture of your financial goals in mind, and research a wide range of options, before deciding where to invest.
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