How to choose an ETF

A good start is to have a clear goal in mind. Why do you want to go into investing? Do you want to maximise returns, minimise risk or invest sustainably? The best ETF for the long term might not be the best ETF in terms of sustainability, for example.

If you need help setting your investment goal and charting your personal plan, get your investing off to a well-informed start in 8 steps.

Just like other forms of investment, investing in ETFs involves risk. You could lose all or part of your investment.

What ETFs are the best fit with your goals? Take a look at the extensive range of ETFs in the Fund Selector. On the left, there are several options that let you filter ETFs based on your preferences. Tick ETFs and then you can filter by things such as sustainability score, sector, and investment style.

Risk assessment

Once you have made your choice, submit your order on Internet Banking or in the ABN AMRO app. You will then be shown a risk assessment that lets you determine whether the ETF you have chosen is a good fit with:

• the level of risk you are prepared to take
• your investment horizon (how long you intend to invest)
• your investment goal

Pros

• You simply track the index, without having to buy and sell a lot of investments (and pay the associated fees).
• You can keep track of the prices of most ETFs from minute to minute and buy and sell most ETFs on an ongoing basis.
• ETFs offer instant investment diversification.
• There are ETFs for different investment assets, including shares and bonds.
• You can invest in sectors or based on specific themes that are otherwise inaccessible to private investors.

Cons

• ETFs are also exposed to a price risk. If the index that the ETF is tracking goes down, the price of your ETF will also go down. Like with regular investments in shares and bonds, you could lose all or part of your investment.
• A passive ETF never outperforms an underlying index or basket. With an active investment fund, your investment may do better than the index.
• No ETF is the same. Some ETFs invest in higher-risk sectors, for example.
• Some ETFs invest only in a single sector or geographical region, thus increasing the risk exposure.

The Sharpe ratio is a measure of returns compared to the risk that an ETF or investment fund has taken over the past three years. The higher the Sharpe ratio, the better. A high Sharpe ratio means less risk and higher returns. If you want to spread risk, you can add ETFs or investment funds with a high Sharpe ratio to your portfolio.

The tracking error shows the difference between the returns of an ETF or investment fund and the returns of the benchmark of that fund over the past three years. It reflects the extent of the unintended deviation from the benchmark that the ETF or investment fund tracks (the error). The higher the tracking error, the more the fund deviates from the benchmark. This can have either a positive or a negative impact on returns. It is primarily a measure of how closely the ETF or investment fund tracks the benchmark.

The standard deviation is a measure of the risk involved in the ETF or the investment fund. It is based on fluctuations in the price of the ETF or the investment fund over the past three years. High standard deviation means a greater price risk. In practice, the return or loss of an ETF with low standard deviation will be less difficult to predict. An ETF with high standard deviation will have higher highs and lower lows along the way.

Alpha is an indicator of an investment fund’s excess return compared to the benchmark. This measure is used mainly for active funds, i.e. funds where the fund manager actively tries to outperform the benchmark. As a result, alpha shows the extent to which a fund is successful in this respect and is a measure of the fund manager’s level of expertise and skill.

Beta indicates an investment fund’s susceptibility to fluctuations in the market. The market as a whole is subject to fluctuations and certain funds are either more stable or more volatile than the market. Beta offers a measure to estimate an ETF’s risk and stability relative to the market as a whole. Investment funds with a beta below one are less volatile than those with a beta above one.

Consider the following features when choosing an ETF:

• Shares or bonds

  Not all ETFs focus on the same kinds of investment assets. For example, there are traditional ETFs that focus on shares from an index or stock market, tracking the result of that index or market. There are also ETFs that combine bonds in a basket, for example. Bond ETFs are often more stable and can help you reduce risk in your portfolio. Share ETFs involve more risk, but they can contribute more to your possible return targets.

• Themes, sectors and geographical regions

  ETFs can also be differentiated based on the sector, geographical region or theme in which they invest. When choosing your ETFs, make sure you don’t invest all your money in one sector or one theme. If you invest only in oil-related companies, for example, you will be vulnerable to losses whenever the oil sector hits a rough patch. Reduce this risk by diversifying your investments and investing in different investment categories, themes, sectors and geographical regions.

• Investment style

  By ‘investment style’ we mean the composition of the ETF’s portfolio. Most ETFs concentrate on share (indices) or bonds. Share ETFs can concentrate on small companies (small caps), medium-sized companies (mid caps), large companies (large caps), or on value-driven or growth-driven companies. Bond ETFs may, for example, be focused on high credit rating, medium credit rating, or low credit rating (high yield and emerging countries). Each style has its pros and cons.

• Transaction and service fees

  When you buy and sell investment products, you will generally be charged transaction and service fees. These fees go towards covering the costs of administering your investment portfolio. The more often your buy or sell, the bigger the impact these fees will have on your returns. There are also ETFs you can trade without having to pay a transaction fee. ABN AMRO’s basic range contains many ETFs you can invest in without being charged a transaction fee.

• Product fees

  There are also fees attached to the product, including ongoing fees incurred by the fund manager. These ongoing fees are the annual costs that the ETF incurs for management, administration, custody, reporting and taxes. Product fees are incorporated in an ETF’s price.

• Benchmark

  ETFs generally try to track a certain benchmark as closely as possible. A benchmark is a standard by which the ETF’s performance is measured. Many ETFs track well-known stock market indices, such as AEX, Dow Jones and S&P500. Other ETFs invest in, for example, global shares or European government bonds, tracking a benchmark composed by a specialist firm for a theme, sector or geographical region.

• Accumulating and distributing ETFs

  The final point to consider is whether you want an ETF that pays a dividend or not. Accumulating (or reinvesting) ETFs do not pay a cash dividend, because they reinvest any dividends received in the ETF. A distributing ETF, on the other hand, does pay a cash dividend, after deducting dividend tax.