Okay, brace yourself. This is going to be a long article. We will explain to you all about investing in ETFs. We go from ‘what are ETFs’, to ‘how to choose an ETF.’ Save this article for later and reread it. There’s no shame in not fully understanding it immediately, we take you into the world of investing, and trust us: the moment it all CLICKS will come. Soon!
What is an ETF?
An ETF stands for Exchange Traded Funds. An ETF, also known as a tracker, tracks an index. This is done by making a copy of an index. Then, a basket is created which mimics price rises and falls in the relevant sector or index. Imagine, you want to invest in all companies of the American S&P index. You can buy individual shares of those 500 companies. You can also invest in an ETF that follows the entire S&P index. Therefore, you invest in all S&P companies, through 1 single investment.
The benefits of investing in ETFs
The advantages of ETFs are that they are accessible and easy investment instruments. You know exactly which index you follow and which stocks it contains. One of the biggest benefits of investing in ETFs is the diversification that comes with investing in an ETF. As there are so many shares, it cannot go bankrupt; minimizing your risk. ETFs are also easy to buy and sell. You open an online account with a broker who then invests in an ETF for you.
In addition, ETFs have low costs. Lower than, for example, investing in funds, where an investment team and fund manager often intervene. These people don’t work for free (duh) and ask for a percentage of your investment to cover their costs. With ETFs, you don’t deal with fund managers and a team, which makes a significant difference.
How is an ETF made?
Okay, we hear you think: how does this product come together? With investing in one single stock, it’s easy to understand that you become co-owner of a company (did you know?!). But how are ETFs created?
An ETF must be built because it must track an existing index. This can be done in 3 ways:
An ETF that exactly copies an index. So suppose you invest in an ETF of the AEX, the same 25 shares that make up the AEX are bought in the ETF in the correct proportion. This way, the exact reconstruction of an existing index, is also called ‘full replication’.
You also have an ‘optimization’. The ETF maker builds the ETF in such a way that it is the most optimal mix. Imagine that it concerns an index consisting of 100 shares, then the builder only buys the most important shares, so for example 80. Because the builder is a smart human being, he has of course done a lot of research on which shares in this index give the best return rate. He eliminates the less performing stocks in this index, and makes it the best possible one.
This way of building ETFs is also done for special ETFs, for example ETFs with a sustainability focus. A lot of times a sustainable ETF follows a whole existing index, and then the ETF maker eliminates stocks from companies that are not compliant to sustainable goals.
This way may differ from the actual performance of the index, because the ETF is not exactly the same, as is the case in example 1.
Finally, you have so-called ‘swap-based’ ETFs. What happens here is that the ETF builder does not buy the stock itself – or part of it as in example 2 – but he agrees with an investment bank that he buys the return of an index. Both negative and positive. These are called synthetic ETFs.
ETFs have difficult names, how to read them?
You want to buy an ETF. You open Google and go for it. And then… hundreds of options appear, all with difficult and confusing names. What do you read, what do all those abbreviations stand for?
If we take a popular Vanguard ETF as an example, we see the following:
The tracker/ETF name: Vanguard FTSE All-World UCITS ETF
Vanguard = the creator of the ETF
FTSE All-World = name of that index being tracked.
UCITS = abbreviation of the rules that the ETF complies with. In this case to European regulations.
Sometimes it says DIST behind an ETF, which means that this ETF yields a dividend. If it says ACC, your dividend is automatically reinvested.
What kind of strategy to choose?
When investing in ETFs, you choose a nice investment asset that automatically diversifies your portfolio. With ETF investing you can sit back and relax. A thumb of rule could be to choose 3 or 4 ETFs with a different diversification.
- An ETF that tracks all the big companies in the world
- An ETF that tracks an index with bunds
- An ETF that tracks high dividend companies in developed countries
- An ETF that tracks companies with focus on sustainability
What the best ETFs are for you has everything to do with your personal investing plan. Important questions to ask yourself when developing your investment strategy:
- What is your goal? 1 year sabbatical in 10 years from now.
- What is the sum of money you want to achieve? I need €50.000 for this goal.
- What is your horizon? 10 years.
- What risk are you willing to take? None! Okay okay, I certainly do not want to lose money.
How to choose the right ETF?
This is the hardest part, not gonna lie. There are many ETFs out there, but which one is the right one? Besides, there are many similar ETFs. They track the same index, but have other names. A few things you always need to check:
- On what exchange can you buy the ETF? If you are based in Germany, ideally you want to trade on German stock markets, because this often is the cheapest.
- In what valuta is the ETF available? If you normally trade with Euro’s, but you are going to buy an ETF that’s based in Dollars, you will pay exchange fees.
Then there’s another extensive list of thingies to check when you have an eye on a certain ETF:
- Size of the ETF. The more money there is in an ETF the lower the risk that the fundmaker will pull the plug. It’s profitable for them, so chances are big this ETF will last a long time. Thumb of rule: 50 million or higher is a safe bet.
- Fundcosts: the maker of the ETF charges fund fees. They need to pay the bills too,so don’t blame them. Around 0,2-0,4% charged annually is okay. But keep in mind that if you want special ETFs, for example sustainable ETFs, the fees might be higher.
- What index is the ETF tracking? What companies are in this index?
- Does the ETF yield a dividend? Would be nice, hello compound interest!
- The historic return on investment, of course.
5 steps to choose your ETF
Okay, so now we know what to check IF we found the right ETF. But how to find the right ETF? We suggest the following steps to take:
- Choose your region. Do you want to follow the global economy or do you believe in emerging markets?
- Choose an asset class in which you want to invest. Do you only want shares, or also bonds? So you choose the type of asset class.
- Choose your industry. Do you want to invest in a specific sector, such as e-sports, technology or sustainable food?
- Choose whether you want a sustainable element.
- Choose whether you want protectors or extras. Such as protectors against dividend leakage, or an ETF that pays out dividends.
‘Aarrggghhh, just give me 3 names of good ETFs, it remains so difficult to choose the right one!’
We hear you. But please understand that nobody but you can determine what is the best investment for you. This all depends on your personal strategy. However, we are not as lame as you would fear. We now share with you 3 classic ETFs. ETFs that are super popular, hold a big amount of money and have proven to satisfy a lot of people.
VWRL: Vanguard FTSE All-World (ISIN: IE00B3RBWM25). This ETF tracks the performance of the FTSE All-World Index. This is an index of shares of medium and large international companies. Annual Fund Fee: 0.22% per year. Average return over the past 10 years: 11.25%. This ETF also has a dividend yield of around 2% per year.
VUSA: Vanguard S&P 500 (ISIN: IE00B3XXRP09). This tracker tracks the performance of the S&P 500 index. The S&P 500 is an American index, you may have heard of it, consisting of the shares of 500 large American companies. The annual fund fee is 0.07%. And the average return over the past 10 years: 9.8%.
IWDA: iShares Core MSCI World ETF (ISIN IE00B4L5Y983). This ETF is very similar to the VWRL ETF. Both are ETFs with a global diversification. The difference is in the spread within the basket. There are also fewer shares in this iShares ETF. The costs are slightly lower. Fund costs per year are 0.20%. The average return over the past 10 years is 12.19%. This ETF does not yield a dividend.
Where to buy ETFs?
You can buy ETFs through a broker. DEGIRO, BUX Zero and Interactive Brokers COULD be an option. Do some research and choose a broker that works for you. Help with choosing one will follow!
At BUX Zero you can invest in ETFs without paying transaction costs. Discover more!