Investing has become more accessible than ever, and one of the key drivers of this shift is the rise of Exchange Traded Funds (ETFs). Whether you’re new to investing or building a diversified portfolio, ETFs offer a simple way to gain exposure to markets. But understanding what they are — and how to compare them — is essential for making informed decisions.
What is an ETF?
An ETF is an investment fund that trades on a stock exchange, similar to individual shares. Instead of buying a single company, an ETF gives you access to a basket of investments, such as shares, bonds, or commodities, in one trade.
Most ETFs track an index. For example, an ETF that follows the ASX 200 provides exposure to Australia’s 200 largest companies, allowing investors to participate in the broader market without selecting individual stocks.
Some ETFs are actively managed, meaning the fund manager selects investments according to a particular strategy rather than simply tracking an index.
Key features of ETFs
- Diversification: Exposure to multiple investments in a single trade.
- Low cost: Many index ETFs have low management fees, offering a cost-effective way to access markets.
- Flexibility: ETFs can be bought and sold during market hours, like shares.
- Transparency: Holdings and key fund information are disclosed regularly.
Because of these advantages, ETFs have become a cornerstone of many long-term investment strategies.
Why ETFs Are Popular
ETFs simplify investing. They allow investors to build diversified portfolios quickly and cost-effectively, without the need for constant monitoring. From broad market exposure to niche sectors or global opportunities, ETFs offer flexibility to suit different goals and risk profiles.
For many Australians, ETFs are used as a core portfolio holding, complemented by other investments depending on strategy. Some investors choose and manage their own ETF mix, while others use professionally managed portfolios, such as those offered by InvestSMART, where portfolio construction and rebalancing are handled for them.
How to Compare ETFs
ETFs can differ in important ways, including their costs, investment approach and level of risk. Here are the key factors to consider when comparing them:
1. Management Fees
Fees are one of the most important factors. Even a small difference in annual costs can significantly impact returns over time.
Look beyond the management fee and check for any other costs, such as transaction costs, performance fees or brokerage when buying and selling ETF units.
2. What the ETF Invests In
Understand what the ETF tracks or how it invests. Two ETFs may both offer exposure to Australian shares, for example, but one may track the ASX 200 while another focuses on dividend-paying shares, a particular sector or a specific investment factor.
It is also worth looking at the ETF’s underlying holdings, country exposure and company weightings. These can affect how diversified the ETF is and the risks it may carry.
Consider whether the ETF’s exposure suits your investment goals and the role you want it to play in your broader portfolio.
3. Past Performance and Tracking Difference
When comparing ETFs, it is worth considering how they have performed relative to similar funds. Look at performance over longer periods where available, rather than focusing only on the most recent year. Keep in mind that past performance is not a reliable indicator of future returns.
For index-tracking ETFs, it can also be useful to consider how closely the Exchange Traded Fund has tracked its benchmark over time. This is known as tracking difference, which is the gap between the ETF’s return and the return of its index.
Some difference is expected because of fees, trading costs, tax and other factors, but a large or persistent gap may be worth understanding.
4. Fund Size (Funds Under Management)
Larger ETFs may be less likely to close or merge, which can provide greater certainty for long-term investors.
5. Fund Structure
ETFs can be structured differently, such as physical ETFs that hold the underlying assets and synthetic ETFs that use derivatives to gain exposure. Synthetic structures may introduce additional risks, so it is important to understand how the ETF is designed.
6. Currency Exposure
For international ETFs, consider whether the fund is currency hedged or unhedged. Currency movements can affect returns, particularly over shorter periods or when the Australian dollar moves sharply.
Bringing It All Together
ETFs can be a useful way to access a wide range of markets, from broad Australian and global shares to more specialised sectors and assets. But not all ETFs play the same role in a portfolio.
Consider what an ETF adds to your existing investments. A broad Australian shares ETF, global shares ETF, technology fund and gold ETF may all be ETFs, but they can behave very differently.
Comparing similar ETFs side by side can help investors assess differences in fees, performance, holdings and strategy. InvestSMART’s ETF Comparison Tool allows investors to compare selected ETFs in one place.
Ultimately, understanding how an ETF works and where it fits within a broader portfolio can help investors make more informed long-term decisions.
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