I still recall back in the days, when I first started my investing journey, I was clueless, and just wanted to go with the easy way of buying a diversified basket of stocks - Unit Trusts/Mutual Funds were always my first go-to option. For avoidance of doubt, since both the terms "Unit Trust" and "Mutual Fund" are pretty much used interchangably in Malaysia, in this article I will be referring both of them as "Mutual Fund" since they're more technically accurate.
I wish I had read about low-cost Index ETFs investing earlier - but I guess now is still never too late! This article will be aimed at those who want to get started with investing through investing in low-cost index ETFs but have no idea how to look for the right ETFs. Rather than telling you what to buy, we'll instead go through the few areas to look at before selecting the fund.
For me, the book that really inspired me to get into the whole shebang of low-cost index ETFs investing is the The Little Book of Common Sense Investing by John C. Bogle whom had democratized the low-cost index fund investing when he incorporated Vanguard Inc. P/S This article is NOT sponsored.
As always - let's first establish our basic understanding of exactly what is ETF before we start going around and scream WTFish!?!?
Dexterity (DEX) nor the Fish has anything to do with Index ETF. Instead, ETF stands for Exchange-Traded Fund. As the name implies, ETFs are listed in our typical stock exchanges where we can trade (buy or sell) just like how we do with our typical stocks - usually with the same commissions/fee structure (and sometimes cheaper too!). Similar to Mutual Funds which are a more well-known counterpart, these funds will typically hold a basket of diversified stocks but have some key differences.
Both Mutual Funds and ETFs are typically created with a specific investment strategy/objective in mind, for example, a technology-stocks focused funds. However, the key differences between the two lies in where Mutual Funds are purchased directly from the Fund Providers (e.g. Principal, Kenanga, Public Mutual) and are actively managed by one or many fund managers with the goal to maximize profits.
Contrary, ETFs are listed in the Stock Exchange just like any other stocks, and can be purchased from any brokers (like Interactive Brokers) where invested funds will be used by fund managers to buy assets based on the initially set strategy, irrespective of market conditions. Fund managers passively manage the fund and do not make any trades to maximize profits, unless when the underlying index / fund strategy changes or when new capital gets injected where they will follow the existing allocation strategy to buy stocks. Ultimately, ETFs underlying assets (or NAVs) are basically a basket of stocks from different companies.
Okay.. what about that "Index" then!? Right... I forgot to explain that bit. The "Index" here is mostly referring to ETFs that primarily aims to replicate the performance of... an index, such as S&P 500. Take an example if I wanted to mimic (US) market's overall performance in my portfolio, without using any of my brain power - I could easily look up the list of Fortune 500 companies and buy all of their company stocks. Except this will probably cost me a bomb with at least 500+ transactions fees incurred.
A better alternative for me is just to buy up the market index, right!?!? Unfortunately I can't do that as market indices are merely "made up" to represent a specific segment of the market and its performance and hence came the "index ETFs" whose funds' sole objective serves exactly that purpose. Instead of buying 500+ separate company stocks like my previous example, I could have just made ONE SINGLE TRANSACTION and buy Vanguard S&P 500 ETF (VOO) instead to achieve the same outcome, with much lesser transaction fees.
With this one single trade alone, I have essentially bought the stocks of different companies like Google, Facebook, Amazon, ... and 490+ other companies in one single trade without incurring 500x separate trades required for such diversification (and along the way more transaction fees). This is especially great for the majority of the investors who may not be great for individual stock picking, and are lazy investors (myself included). As Warren Buffett once said,
A low-cost index fund is the most sensible equity investment for the great majority of investors
Warren Buffet
Now, you may be wondering: "If I wanted diversification, why not just go with Unit Trust/Mutual Fund and let the professionals manage the fund for me?"
For many people, the idea of doing it yourself to buy Index ETFs can be both daunting and overwhelming. Amongst many of my friends/colleagues, when it comes to managing finances/money, one of the most common sentences that I have always heard time and time again is the following:
I don't know enough about managing money, so it's better off for me to leave it to the professionals.
Random Friends / Colleagues
The most common route that non-financially savvy folks will opt for, when it comes to investing after getting enough of the fixed deposits will usually be Insurance "Savings" plan and later, Mutual Funds/Unit Trusts. These are typically signed up through your friendly agents, friends or even relatives as some of them may already work in the financial industry. Whilst not all apples are bad nor people are inherently bad, the systems in Malaysia unfortunately does not help either.
Often, people don't even know what they had signed up for and blindly trusted their friends / agents. Who at least reads up the insurance policies before signing on the dotted line? I know I do. I don't want to repeat myself too much since I've ranted enough about these on my Getting Started - Financial Freedom for Malaysians! post, but in short from my perspective, the reasons to go for DIY Index ETFs instead of Mutual Fund/Unit Trusts or even RoboAdvisors ETFs are the following:
But of course, doing it yourself is not all rosy and beautiful. There's definitely more works to it as you can't simply have Direct Debit setup to directly deduct funds from your Maybank (or other Malaysian banks) and invest onto ETFs offered by some RoboAdvisors providers like StashAway. For most folks, I would still recommend to go for RoboAdvisors like StashAway as it's much more simpler and less headache for the less adventurous ones but for those who are willing, read on more!
Note that this article will not cover the transactional aspects of buying/selling the ETF 'stocks'. If you need guidance on that, feel free to check out my previous post on Beginner's Guide: Investing Abroad via Interactive Brokers from Malaysia as that's what I use to buy my ETFs.
Picking an ETF can be a simple exercise - some closed their eyes blindly and purely follow recommendations from their favourite book's author, their favourite bloggers, or whatever's hot in the market today.
However, some would like to at least have some sciensy logic to it rather than doing it blind. Afterall, knowledge is power, isn't it?
Whilst I won't be able to cover every single aspects on this topic (as it's pretty broad topic afterall), I will point out some key considerations that I personally exercise when picking my ETF funds.
As there are many varieties of ETFs, with "Index ETFs" being just one of those, you need to be clear on the selection of fund with its strategy/objective aligning to your personal investment goals.
Personally for me, since I'm going after low-cost Index ETF's, the fund's strategy must align as such with the sole purpose to replicate market index's performance.
Closely related to the above, the strategy/objective will usually also include a specific sector (i.e. technology, green energy, oil, etc.) or geographical area (i.e. US, Greater China, Asia Pacific, etc.). Depending on what your overall portfolio allocation plan, you may need to fine tune this to hit your allocation targets.
Personally for me, since I strive to maintain 30/30/40 between US/China/Others incl. Fixed Income or Gold; I mix in several broad-based ETFs and region-specific ETFs to increase my exposure to certain region.
Probably one of the most important criterion amongst others - where the fund is domiciled (or "set-up" in layman term). In the end, the monies you invested will be used to buy underlying assets (e.g. Amazon stocks) so you will end up holding the same "asset". However, depending on where the ETF fund is domiciled at, your tax treatment may differ. Consult a tax professional to get advice on this one, or visit online sites like Bogleheads which has good information on this topic to avoid common US tax-traps.
Personally for me, since I'm a Malaysian Citizen and also a Tax Resident in Malaysia (they are two different things!), unfortunately this also means that I'm disadvantaged to directly hold US assets/stocks since there are no tax treaty between US and Malaysia and I'm better off to hold US assets indirectly through funds domiciled offshore, such as Ireland.
The currency used for the listed ETF. This one really do not have too much of an impact - in the end, whatever currency you opt for and deposit into the brokerage (and later fund provider) will be used to buy underlying assets, which are typically stocks listed in their origin exchanges/currencies. Most will opt for currency that works in their favour to reduce the number of currency exchanges to be done.
Remember ETFs are listed in the stock exchange, like any other stocks? You've probably guessed it then! Depending on the broker that you use, they may have different transaction fees based on stocks / ETFs purchased, and are also influenced by factors such as the Stock Exchange (i.e. London Stock Exchange charge more on average).
Personally for me, I am using Interactive Brokers since they provide me with global worldwide access, most importantly to London Stock Exchange where I transact for most of my Ireland-domiciled funds.
Another important criterion here which directly affects the amount of fee you have to pay (usually per annum), deducted directly from the capitals held. Most low-cost index ETFs come with an expense ratio of approximately 0.15% to 0.50% on average, depending on fund provider, fund domicilation and fund size.
Personally I try to keep this as low as possible, but are usually limited by other factors such as fund domicilation / taxation.
Some companies may choose to distribute dividends on a periodic basis, which essentially are cash given to investors. Since we are holding the company stocks via an "intermediary" (i.e. the index ETF), depending on the type of ETF we purchase - whether Accumulating or Distributing, the treatment of the dividends received will be different.
In a perfect scenario (where there are no transaction fees etc.), there are no differences as to which model you choose but in reality, since we'll be dealing with brokerages which will likely charge us fees for any/every transactions made, Accumulating is almost always better, except if you need the cash (i.e. during retirement years).
Personally, I opted for Accumulating funds where possible since I would like to avoid receiving small sum of cash in my brokerage account, and incur additional transaction fees just to "buy back" additional ETF shares. At least with 'accumulating' funds, the re-investment is done at fund provider level which bypasses my brokerage and saves me transaction fees.
Fund size simply refers to the amount of funds held in the ETFs, or in proper terms, assets under management. The large the fund size is, the easier it is for the fund providers / managers to optimize costs and bring down expense ratios. The lower the expense ratio, more people will be willing to opt for the ETF (vs. competition) and hence providing better liquidity for buyers/sellers to trade at fair value.
If the ETF has bad liquidity, often, the asking / bidding price on the stock exchange may differ from the actual Net Asset Value (NAV) of the asset, hence creating a disparity and resulting in a loss (or gain in some cases).
Personally, since I don't intend to trade often, I did not prioritize too much on this point so long as the fund size is of reasonable amount (hundred of millions or billions).
Another pretty important criterion, especially for index ETF investors. What's the use of an Index ETF if it can't even accurately trace an index? Imagine buying a S&P 500 Index ETF only to find out that its performance is nothing like the SP500...
Tracking accuracy is nothing, but as its name imply, how accurate the ETF is tracking the Index.
Phew, that's a long list of definition and explanation. It might be hard to digest everything at one go, so perhaps a better way to learn is to pick some real examples and go through them together to see how it works in action?
For the sake of disclosure, none of the ETF's written on this post shall be treated as a recommendation. Please do your own due diligence and research before deciding on one. I am merely sharing real examples so that you can at least understand see how/what goes through my head when I was deciding for "the ETF(s)" that I had opted for.
Let's run through a scenario - say, I am looking to buy a broad market index funds like S&P500. However, we know that S&P500 are made up of 500+ US-listed companies with 100% exposures to the US market. From a quick analysis, I also found that my portfolio is already US-heavy, and I wanted more exposure into the China market (for better or worse...).
I can go for several approaches here:
Now that I have decided that pathway 3 may suit me better, I looked up various options and found that Vanguard Total World Stock Index Fund ETF (VT) may suit my need. Let's run through the few criterias that we discussed earlier.
| Ticker | VT listed in the New York Stock Exchange |
| Strategy / Objective | Total World Stock Index Fund seeks to track the performance of a benchmark index that measures the investment return of global stocks. |
| Sectors / Geographical | FTSE Global All Cap Index (global large, mid and small caps with exposure of 60% US and 40% other countries) |
| Domicilation / Taxation | United States |
| Currency Denomination | USD |
| Transaction Fees | Depending on brokerage. Since I'm using Interactive Brokers, at least a minimum of $0.35 per transaction and goes higher from there depending on transacted amount. |
| Expense Ratio | 0.07% |
| Dividend Model | Distributing (Quarterly) |
| Fund Size / Liquidity | Approx. $39.95B in Assets Under Management with average 1,260,516 trading volumes daily. |
| Tracking Accuracy | Almost 100% (visually), or R-Squared value of 1.0 (no tracking errors) |
Now, where did I find those information, you may ask. I typically like to comb through multiple websites, primarily from the fund providers' provided fact sheet, Yahoo Finance, and also some ETFs-focused website as many of those information are already compiled.
After considering all these information, whilst I liked this ETF especially with the low expense ratio, I didn't like the fact that dividends are distributed (incurring me transaction fees to re-invest via brokers later) and the funds are domiciled in the US (which is disadvantaged for me) hence I had to look for an alternative. Maybe something of equivalent but domiciled elsewhere?
That's where I found Vanguard FTSE All-World UCITS ETF USD Acc (VWRA), and if you look at the facts below, it'll almost be dejavu except for underlined changes. It is basically a replica of VT, except for the stock exchange listed, fund domicilation, slightly higher expense ratio but with an accumulating dividend policy. Of course, this one have way lower average daily trade volumes and almost less than half asset under management but it'll do for now.
| Ticker | VWRA listed in the London Stock Exchange |
| Strategy / Objective | Total World Stock Index Fund seeks to track the performance of a benchmark index that measures the investment return of global stocks. |
| Sectors / Geographical | FTSE Global All Cap Index (global large, mid and small caps with exposure of 60% US and 40% other countries) |
| Domicilation / Taxation | Ireland |
| Currency Denomination | USD |
| Transaction Fees | Depending on brokerage. Since I'm using Interactive Brokers, at least a minimum of $1.70 per transaction and goes higher from there depending on transacted amount. |
| Expense Ratio | 0.22% |
| Dividend Model | Accumulating |
| Fund Size / Liquidity | Approx. $19.12B in Assets Under Management with average 48,276 trading volumes daily. |
| Tracking Accuracy | Almost 100% (visually), or R-Squared value of 1.0 (no tracking errors) |
And that's basically it! Going through all the steps above have helped me to finalize and shortlist VWRA as one of my favourite ticker as it meet most of my criteria - being globally diversified with exposures beyond US, tax advantages, rather-low expense ratio, and etc.
Unfortunately, not all index ETFs have sister listing in Stock Exchange / Fund Domicilation outside of home country - in cases of Greater China ETFs. So depending on your use case, you may / may not come across the "perfect one" that suits you. As with life, you just need to make the best decision that you can given the various constraints.
I hope the above step-by-step walkthrough helps you to understand how to select and find your favourite low-cost index (ETF) funds. Always remember to come back to your investment strategy as that will ultimately fuel all your other decisions.
As always - thanks for reading and see you again in my next post! If you haven't already, be sure to follow me on my Instagram, Facebook and YouTube for latest updates!
Cheers,
Gracie
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