Last update: 17.09.2024 08:34
A simple guide for anyone who wants to buy an automatically managed fund for the first time and is looking for the right product. And also for those who are looking for a way to invest their money for fewer fees.
What is an ETF?
Exchange traded funds (ETFs) are listed, passively managed funds. The securities contained in the fund track a specific index and the funds distribute their assets (i.e. investments) according to the market value of the investments in the index. This means that the performance of these funds always develops in line with the index.
ETFs follow an index that is regularly calculated by an index provider. Well-known providers are MSCI, FTSE or STOXX. The composition of the investments that belong to an index differs slightly from index provider to index provider.
ETFs are not actively managed by a fund manager. Investment is passive and automated. This results in lower costs. The performance is generally slightly worse than that of the underlying index. The difference between the index return and the ETF return is known as the tracking difference. Skillful providers can keep this difference small.
How do I find the right ETF?
There are thousands of passive funds on the market. These include exchange-traded funds (ETFs) and index funds. You can compare ETFs on various platforms. For example, justetf.com is simple and comprehensive. Under “ETF search” (no registration required) you can search for ETFs by topic or index, for example, and compare them with each other. At the same time, it is also worth checking which ETFs you can actually buy via your custody account provider. Sometimes not all of them are available. But how do you find the right ETF?
Determine asset class
Depending on your risk appetite, you can choose ETFs on equities, bonds (also known as debentures or bonds), the money market (i.e. very short-term fixed-interest investments), commodities, precious metals or real estate. Equity ETFs are the riskiest and therefore more suitable for a long-term investment horizon (7-10 years and more), as they have historically achieved the highest average annual returns over long periods of time.
Determine investment focus(es) and allocate investment amount
The question is: Which market should your ETF cover? As a rule, ETFs are chosen as a long-term investment with the aim of spreading risk, i.e. diversification across as many companies of different sizes and regions as possible. Otherwise you could bet on individual stocks. Therefore, if you don’t have any ETFs yet, it’s best to start with a broad-market ETF that covers as many regions as possible. This is a so-called world ETF. If your portfolio is already well diversified and you want to focus on a specific market, there is a wide selection of ETFs that focus on specific regions (e.g. emerging markets or Asia) or themes.
Choose distribution strategy for income: Payout or reinvestment?
There are two different types of ETFs: distributing and accumulating. The ETFs hold investments and these investments generate income. The income flows into the fund assets, for example dividends in the case of equity ETFs or interest in the case of bond ETFs. You are entitled to this income as a shareholder. How would you like to receive them? Distributing index funds automatically pay you the share of income attributable to your unit into your custody account: you have a regular income.
Distributing funds reduce your risk and are usually easier from a tax point of view because a distribution slip is sent along. It is also motivating to “get something out” of your savings on a regular basis.
Accumulating ETFs reinvest the income directly for you. You either receive further fund units or the value of your units increases. This accelerates the accumulation of assets through the compound interest effect and as you do not receive the money, you cannot spend it. You also have to declare the income from accumulating funds in your tax return.
Select the desired index replication: physical or synthetic
Decide between physically replicating and synthetically replicating. Physically replicating ETFs replicate the performance of an index by either buying its components in full (full replication) or by replicating the majority of them using optimized sampling. Synthetically replicating ETFs replicate the performance of an index through swap transactions with a counterparty. Swap transactions can be thought of as a contractual promise to exchange future cash flows between financial institutions. Synthetic products are usually somewhat cheaper. The trend in the market, both among fund providers and customer demand, is clearly moving towards physically replicating products – there is no counterparty default risk and it is clear in which securities your money is invested.
What do I need to bear in mind when investing in ETFs?
Choose a tax-efficient ETF
Choose a product that doesn’t cause you any stress when completing your tax return, i.e. is tax-simple. It’s easy if the provider transmits the tax values and income data to the Federal Tax Administration. You can find out whether this is the case, for example, at justetf.com to check. If it says “ESTV-Reporting” for an ETF under Tax status Switzerland, it will transmit the tax-relevant data for the corresponding financial year to the Swiss Federal Tax Administration. If you do not receive the necessary information with the annual custody account statement from your online broker, you can then go to the webpage of the EStV.
Pay attention to low costs
ETFs incur one-off and recurring costs. One-off costs are incurred when buying and selling the ETF. These include the brokerage fee for your online broker as well as stamp duty, stock exchange fees and the so-called spread. The spread is the percentage range in the price at which the ETF is offered or demanded. The smaller the spread, the better for you.
Recurring costs are charged annually either directly to you (as a flat-rate or percentage custody account fee) or to your ETF investment assets and reduce your return. The total expense ratio (TER) essentially comprises the costs for fund management fees, advertising and product distribution, but not the transaction costs at ETF level. The lower the TER, the better for you.
Our tip: How to find ETFs with a low total expense ratio
The following tips practically automatically result in a reasonable total expense ratio. For equity ETFs, it should definitely be below 0.5% per year. You can also get ETFs on very large indices for less than 0.1%.
- Choose a top dog: Large ETF providers are in strong competition with each other. This stimulates business and lowers fees. The major providers include iShares, Lyxor, db X-trackers, Amundi, UBS and Vanguard.
- “Big is beautiful”. Choose an ETF with an investment volume of at least 500 million. This ensures good tradability and small spreads.
- Look at the fund age. Make sure that the product has been on the market for at least 5 years.
- Avoid exotic indices. Invest in well-known indices from well-known index providers such as MSCI, FTSE or Stoxx.
Summary
Choosing an ETF yourself is not that difficult. First you choose which asset class you want to invest in and then select the product’s investment focus(s). Then you filter the list of available products based on the distribution strategy and the type of index tracking. Finally, make sure that the product is tax-efficient and has low fees.
We mean: so that are well equipped to invest in the financial market. Don’t wait too long, because as the Chinese philosopher Lao Tzu said: “a journey a thousand miles long begins with a first step”.
Mach den ersten Schritt zur finanziellen Unabhängigkeit
In einer Minute siehst du deine Vermögensentwicklung und dein Einkommen während der Rente.
