An Exchange Traded Fund (ETF) is a great way to get instant diversification with just one trade, and is perfect for the passive, long term investor. ETF’s have only continued to become more and more popular, and for that reason the number of ETF’s have grown considerably. There are ETF’s for whole markets (AU, US, UK, etc), different industries (agriculture, IT, banking, etc), different commodities (gold, oil, lithium, etc) and soon there will be some cryptocurrency ETF’s available in Australia. Thanks to the abundance of ETF’s, there are plenty of options for you and there is an ETF for every need. The downside to this is when you are starting out the amount of options can leave you overwhelmed and potentially give you analysis paralysis (a term for being so overwhelmed with making a decision that you make none). I’ve written this post as a bit of a guide to what to look out for, what you look for in an ETF, and why you may choose one over another, in hopes it will help get you invested sooner.
1. What Do You Want to Invest In?
The first thing to look for when looking to invest in an ETF is to think about what you personally want to invest in. For example, you may just want a simple, uncomplicated, highly diversified fund (for example VDHG) that covers you for the whole world and keeps it easy for you. On the other hand, you may want a very specific ETF that invests in, for example, only ethical companies (e.g. ETHI, VESG) or something that only invests in tech companies (e.g. NDQ). Asking yourself what you want to invest in and why is probably the first step to finding the ETF/ETF’s that is/are right for you.
2. Are You Looking For Income or Capital Growth?
The next thing to consider when looking to invest (in anything for that matter) is whether you are wanting capital growth, or a good yield/income. With shares and ETF’s, capital growth comes from the increase in share price, and you don’t need to pay tax on the profit until you sell. Also, if you hold onto the share for more than one year, you are entitled to a capital gains tax discount. If you are looking for income when it comes to shares, this will be through the dividends. Dividends are payments made from the company to the investor (you) at set intervals throughout the year. These can come quarterly, bi-annually or annually. You will have to pay tax on these when you receive them, however some companies may have already paid tax on some of the profits and you can receive franking credits for your dividends. This basically means that you may not need to pay tax on the majority, if any, of your dividends. This provides a great, tax effective way to earn money, and you will see many retirees living off these low taxed dividends.
Obviously, if you can have both then that is ideal- but it’s not always possible! Generally speaking, tax concessions are better for dividends here in Australia and therefore most of our top companies pay out their profits to investors as dividends. In America, the opposite is true, and some large companies will never pay a dividend to an investor. Instead, the company will reinvest that profit back into the business to increase it’s capital and therefore increase its share price.
Personally, I invest in both Australia and the US, so I get a healthy mix of capital gains and income. There are high yield ETFs available, which invest in companies that pay high dividends and are usually Australia based. This could be an option if you are searching for that income, otherwise almost any US ETF will provide you with strong capital gains over dividends.
Once You Have Chosen the ETF’s Type/Region/Industry..
Once you have decided on the style of ETF you are looking at & the region it is in, you may have a few similar ETF’s to choose from and don’t know how to distinguish them further. There are a few ways to work out which will be best for you, however at the end of the day if all of the ETF’s are invested in what you want to be invested in and align with your values, these next few things aren’t going to be a very high priority.
Fees are definitely worth looking at, and for most ETF’s they should be pretty low as they are generally passively managed. Comparing the fees between funds may help you decide which provider you will go with. For example: A200 fee is 0.07% & VAS 0.10% fee. You may choose to go with A200 as you like low fees however both of those are ridiculously low and good value in my opinion.
Number of Holdings
Another thing to consider is the number of holdings the ETF’s have. Using the same example as above, the A200 ETF has 200 holdings, while VAS has 300 holdings. If you want just the top 200 hundred companies you may choose A200, or if you want even more diversification, you may go with VAS.
Equal Weighted vs Market Cap Weighted
Another difference between ETF’s may be how they are weighted. There are two different ways, either they are equal weighted, or weighted by market capitalisation. Equal weighted means that the companies all make up the same percentage of the ETF. For example, if you are looking at a ETF with 100 companies, each company will make up 1% of the ETF. An ETF weighted by market capitalisation will mean that the biggest companies will make up the largest portion of the ETF, and reflects the index it is tracking. For example, CBA has the largest market capitalisation in the Australian Share Market, so an ETF tracking that will have CBA taking up the largest percentage of the ETF.
If you believe the big companies are the ones that will continue to perform, you may want to invest in a market cap weighted ETF. They take up the majority of these ETF’s so if they do well the ETF will do well. If you think the smaller companies will perform better, you may want to invest in an equal weighted ETF as they will have the same weighting as the large companies and probably a larger weight than what they do in market cap ETF’s.
Things You Shouldn’t Compare:
Share price per unit
The actual share price in comparison to other funds doesn’t really matter. It doesn’t matter how many units you own, it only matters how much you have invested.
If you have $3500 invested in Amazon, and $3500 in Commonwealth Bank of Australia, you will have:
- Amazon- 1 unit
- CBA- 34 units
At the end of the day, it doesn’t matter if you have one or one hundred units, it matters only about the dollar amount. In this example, you have $3500 of Amazon and $3500 of CBA.
Past performance is not a reliable indicator of future performance, and therefore should not be used to base a decision on. While it can give you some insight into how the fund is performing it should not form the basis of your entire decision.
It is important to note that while you can look at these things to make a decision, at the end of the day, it’s best to just invest in something rather than wait trying to make the ‘perfect’ investment. How I invest now is different to how I was when I started, but if I had spent this last three years trying to decide exactly how I was going to invest without diving in, I would have missed out on all the gains I’ve now made. You can always change your tact later, and that is the same for which broker you go with as well. Just getting started is better then waiting for the perfect time, and buying any investment is going to be better then buying the “perfect” one (if that even exists). So don’t be shy, have a look at some of the websites below, find an ETF that is interesting to you or you think will do well, buy it, and hold on for the ride!
Don’t Know Where to Get Started? Try Pearler!
Pearler literally makes it so easy to get started, you can search some of the most popular ETF’s and see what you like there. If I want more information on the ETF I just google the code (normally three or four letters) and look at the ETF’s website for more information.
If you think Pearler may be for you, use the code MINDOVERMONEY to get a free trade! Sign up is free, there is no minimum number of trades and no minimum amount to transfer in to the account. If you want to try something else, there are plenty of other brokers out there. If you want more market data and research, try one of the big four banks. Or if you want something cheap like Pearler, you could try Self Wealth or Super Hero. At the end of the day, any investing is better than none so get started!
If you aren’t ready to start but want to start doing some research, have a look at some of the websites below of the major ETF providers here in Australia. You might see something on there that sparks your interest enough to sign up to a brokerage platform!
The ETF’s on all of these websites can be bought through any brokerage platform that trades on the ASX- this includes Pearler, Self Wealth, Commsec, Nab Trade & many more!