Low cost, and big on diversity, there are good reasons why ETFs play a key role in Robo Advice.
Exchange traded funds (ETFs) are a type of managed fund listed on the stock exchange.
The appeal of ETFs is that you get immediate diversity – across different shares, sectors and even geographic regions, backed by very low fees.
How ETF Fees Are Kept Low
Most (though not all) ETFs are index funds – also known as passive funds. This means they aim to replicate the performance of a particular market index, like say, the ASX 200.
It is the passive approach of index funds that helps to keep their fees so low.
The annual fees are often below 0.4%. So more of your money goes to your portfolio – and less to the fund manager.
The Benefits of Indexing
ETFs take a very different approach from actively managed share funds, which typically aim to outperform the market by picking stocks that will deliver healthy gains.
For investors, it can seem to make more sense to try and beat the market rather than match it as an ETF will. But there’s a catch.
Actively managed funds require a lot more effort to try and second guess the market. So the fees are higher – often around 2.5% annually. That’s a lot more than ETFs.
The problem is that beating the market is extremely hard to do consistently.
The SPIVA Scorecard tracks how well actively managed funds outperform the market over time. In 2021, the SPIVA Scorecard for Australia shows that over the 12 months to December 2021, 42% of actively managed share funds failed to beat market returns. And the success rate falls over time.
Over the three years to the end of 2021, 62% of actively managed funds were beaten by the market, and over ten years, just 21% of funds were able to outperform market returns.
Managing Costs Is Easier Than Beating the Market
The upshot is that it’s hard – if not impossible, to consistently top market returns. Yet investors pay the higher fees of actively managed funds regardless of whether their investment has earned gains or losses.
This highlights why ETFs have become so popular among Aussie investors.
Sure, not all ETFs are passively managed index funds, but the common thread is very low fees. That matters because outperforming the market year after year is exceptionally difficult. Taking control of the fees you pay on your investments is a lot easier to do.