What are ETFs?

etfThey are Exchange Traded Funds.  Huh?

Simply, an ETF is an investment fund that is traded on a stock exchange.

Although the ETF is similar to a mutual fund (or unit trust) and comprised of many individual investments such as stocks, bonds, or both, but unlike a traditional mutual fund, you can buy its shares throughout the day on major stock exchanges.

Its price is close to the Net Asset Value, or NAV, or value of the underlying securities.

Exchange Traded Funds burst on the investing scene less than 20 years ago and continue to command center stage.  They have surged in popularity in recent years, thanks mainly to their low cost, ease of trading, tax-efficiency, and transparency.

What’s so great about ETFs?  If they are similar to a mutual fund, why wouldn’t an investor just invest in a mutual fund?  Well,  ETFs usually sport significantly lower fees than mutual funds and offer greater flexibility.  In addition to trading throughout the day, they can also be shorted or purchased in small amounts.

The main reason for the lower fees is that an ETF Index Fund is just mirroring the respective stock index, and that mirroring can be performed by a computer under minimal human supervision.  Therefore, all those experts “managing” a mutual fund (by deciding what to buy and what to sell) are non-existent for ETFs.

Why choose an ETF index fund?  Index fund investing has become one of the leading investing strategies.  This approach recommends that instead of trying to beat the market—by choosing an active fund manager (or buying individual stocks and bonds oneself)—the investor is better off buying into the major stock indexes and settling for a market-matching strategy.

Are you sure that ETFs would give me a better return?  Numerous studies have shown that index funds are superior to up to 96% of all mutual funds (studies eliminated the survivorship bias, including those that have been shut down or merged, and after taxes and fees) when compared on an apple to apple basis over a longer time frame, like 5 years.

I am passionate about ETFs because history has shown that they are the superior investment vehicle, despite that you might not have heard too much about them because there is not much marketing of ETFs (good products do not require excessive marketing to sell well).

It’s just that established banks and fund houses have a larger marketing budget and machinery to “convince” retail investors of the “advantages” of mutual funds.  And they can afford it, thanks to the huge management fees they collect from those faithful investors year over year, irrespective of the actual performance of the respective.  And they have to, in order to attract enough fresh funds to feed the armies of people working in the Mutual Fund Industry.

This madness has to stop!

There are simply too many hidden costs linked to mutual funds and you indirectly pay a pyramid of financial advisers who only have your best interest on their minds (yeah, for real).

Don’t get me wrong, mutual funds are not all bad.  They are still a better option than letting your money shrivel away in a Fixed Deposit over a long time.  But why settle for second best when the best is within easy reach?

Just take a look at the tremendous growth of ETFs percentage-wise in the US: 1,110%  in the last 10 years.

Investment Firms Manage 17 Trillion 2014-05-28_150046

Yes, the mutual funds did grow as well (203%) because the overall stock market was doing well and because long-term investors in mutual funds usually do not change their horses.  Old habits die hard.

Have a second look at their performance.  There are many that performed better than 8% p.a. over longer time frames:

Biggest ETF longterm performances 2014-08-22_220907

Top US Index Funds Over Long Run 2014-08-07_172121

You say, “Ok, but that is quite a boring style of investing and I am very good and confident in selecting my own stocks out of the 10,000 listed in the US and the other 30,000 listed in the world.”

Are you sure about that?  Statistics speak another language:

S&P Returns vs average investor 2014-08-20_090238

And do remember that not everyone can be above average.  That is mathematically not possible.

ETFs it is then.  Just watch out for the following three areas and you are set:

1) Stay away from “Leveraged ETFs”.  They are meant primarily for short term holding periods only.

2) Tread very carefully when investing in “Commodity ETFs”.  I just say, contango,”  and that has nothing to do with that sexy dance from Argentina.  By the way, did you notice that Argentina lost to Germany in the 2014 World Cup Finals? (I just had to mention that, I am German after all…)

Sorry, I digress.  Back to

3) Do not forget to delve into the fund’s holdings (just Google the respective “ETFs ticker symbol + holdings”) and you would know what you are investing into.  ETF fund names can sometimes be a bit misleading.

How to buy those ETFs?  The easiest way is via your online brokerage.  Another option is to talk to your trusted Relationship Manager of your local bank and ask for his help in helping you to set up a Regular Savings Plan for ETFs.

Be aware that he might be quite reluctant to do that as he would prefer to sell you the fee-laden mutual funds instead, thus providing him with a nicer commission.  Do stand firm and ask him to provide you with only what you asked for.  Don’t be angry with him though as he is just trying to do his job and “push” the products his boss wants him to sell.

If you were under the illusion that your banker has your interest in mind, you may have to discard that view now and face the selfish reality of the financial service industry.

I promise you that investing that one hour to set up a Regular Savings Plan with ETFs and sticking with it for 20+ years will give you peace of mind, and after 20+ years, a big smile.  It worked for me.

Now, in case you live in Singapore and would like to know how to automate your ETF-investing in a local context, have a look at Lionel’s blog.  He is an expert in long-term low maintenance investing—to harvest the magic of compounding and low fees.  The generous and focused chap that he is, he even offers a free video course of Index Investing.

3 Comments

  1. Constance Wong

    Hi Andy, May I know did you purchase the system from Lionel too?

    • Hi Constance,
      Lionel does not sell a system per se. About one year ago I bought his great E-Book on Automatic Investing where he describes everything step by step.
      In the mean time he has ‘upgraded’ the E-book to a full-fledged video-course on ETF-investing, which is available on his website.
      I hope this answered your question.
      Andy

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