Comparing ETFs

Investing in ETFs is an effortless way to achieve a high degree of diversification. Most ETFs are passively-managed and follow a certain index, meaning that they aim to achieve the same performance as that index. Therefore, it's not uncommon to choose the index first when looking to invest in an ETF.

Once you've found an index with the country and sector exposures that fit your preference, you might then search for an ETF that replicates that index. But if the index that you've chosen in popular, you might actually find many ETFs are following that index (for instance, there are hundreds of ETFs with the S&P 500 as their benchmark).

So what other criteria can you use to differentiate these ETFs and find the one that fits you best? Below are the factors that can be considered.

Cost

Even passively-managed ETFs have costs entailed (e.g. the fee for the index providers and cost of rebalancing the ETF composition when the index is updated). These costs are charged to the ETF which are ultimately paid for by the holders. Even with these fees, holding an ETF is still a very cost-effective way to build a diversified portfolio. But since ETFs charge different fees, you might be able to save considerably over the long term by choosing a cheaper ETF.

The currency of the fund would also have an effect on the long-term cost of holding an ETF. If an ETF is denominated in a different currency from the country you live in, you would need to convert currencies for every transaction. This means incurring costs in terms of the fees and exchange-rate spread for the currency conversion. However, if the currency exchange fees with your online broker is low, then it's likely better to just go for the ETF with the lower cost regardless of the currency.

The stock exchange where the ETF is domiciled also plays an a role in determining its cost. Some exchanges charge additional fee for every transaction, which might seem small but add up over time and the number of transactions. Thus, it's important to pick an exchange which has low fees. Furthermore, the domicile of the ETF might have tax implications to you. It is crucial to check that the ETF is the most tax efficient for you, to avoid any unpleasant surprises in the future.

Credibility

The credibility of the fund is also an important factor to consider. Larger ETFs that have been around for a long time is at a lower risk of being closed, making them a better fit for long-term investing. Choosing an ETF from a known fund manager with a long track record (e.g. Vanguard, BlackRock, State Street) also provides another layer of credibility to the ETF.

Another critical factor is the method the ETF uses to replicate the index. These are the typical replication methods:

• Physical: aims to buy and hold all members of the index
• Sampling: aims to buy and hold part of the index
• Synthetic: aims to replicate the performance of the index by purchasing derivatives and swaps

If you're going for a well-known index, you would likely find an ETF that tracks it using physical replication, which should result in better tracking error compared to sampling and carries less risk than synthetic ones.

Diversification

As mentioned above, ETFs are great vehicles to achieve diversification in investing. Some ETFs offers the possibility of investing in hundreds or thousands of stocks just by purchasing one product. The level of diversification the ETF offers will depend largely on how the index it follows is defined. If the index only includes stocks from a certain region or sector, it would likely have a lower level of diversification even though it might still include a large number of stocks.

Another thing to keep in mind is that most indexes are market capitalization weighted, meaning that larger companies carry a higher weight in the index. For instance, in indexes where Apple and Microsoft are represented, these companies with large market capitalizations will represent a larger chunk of the index than smaller companies. This is not necessarily a bad thing, but it's definitely worth knowing if a significant part of your investment is concentrated in larger companies and might not be as diversified as it might seem at first glance.

Unit Price

This factor is rather a technicality compared to those above. If you are comparing between two ETFs with very similar characteristics, which one should you choose? In this case, I would choose the ETF with the lower unit price.

These are just some reasons why the unit prices might not be the same:

• different unit price when the ETFs were first created
• one ETF has been in the market longer than the other

Choosing an ETF with a lower unit price would allow most of the cash to be invested. It is especially useful when following the dollar-cost-averaging strategy, where the same amount of money is invested at regular intervals. The table below shows an example.

This is also part of the reasons why some stocks are split when their prices get too high. Lowering the price makes it more attractive to retail investors, since it's easier to purchase a unit of the stock.