Why should you choose ETFS?

What should you look out for when buying an ETF? Selection criteria

Compared to actively managed investment funds or certificates, ETFs have a simple structure and are very transparent. Nevertheless, it is advisable to think about a few key criteria before buying. These are the most important:

The index shown

An ETF only passively tracks an index instead of actively pursuing its own strategies. It is all the more important that investors make sure that they choose the right index for their investment objective when buying a product. Some indices contain only a few stocks or are calculated according to criteria that are difficult to understand. This is often the case with so-called strategy indices. These try, for example, to combine stocks with particularly high dividend payouts or particularly high-growth companies in one index. Private investors should basically concentrate on established indices from large providers that cover as large parts of the market as possible and are systematically structured.

  • For stocks in the euro zone, this is about the Euro Stoxx 50,
  • for the whole of developed Europe the Stoxx Europe 50 or the even broader Europe Stoxx 600.
  • For North American stocks, the S&P 500, MSCI USA or MSCI North America come into question.
  • The established index for stocks from across the developed world is the MSCI World.
  • The MSCI Emerging Markets has prevailed for investments in emerging markets.
  • The MSCI All Country Wold Index and the FTSE All World Index represent an even broader diversification with more than 3000 shares.

ETFs from various providers exist for all of the indices mentioned.

Bond indices are generally less well known than equity indices. But here, too, the following applies: Investors should look what is in an index. The remaining maturities of the bonds included, the creditworthiness of the issuer and the currency in which the bonds are listed are important. Corresponding information can be found on the websites of the investors or in financial information portals on the Internet.

The costs

In principle, almost all ETFs are cheap. Actively managed equity funds often charge an annual management fee of 1.5 percent - or even more. In the case of ETFs, on the other hand, the management fee is usually well below half a percentage point per year. Nevertheless, the same applies here: It is important to compare the products of several suppliers. For example, there are providers who expressly reserve the right to pay sales commissions to banks and other fund brokers in the fund prospectus. Such commissions can result in higher costs that investors ultimately have to bear.

Another factor: the more exotic the index that an ETF tracks, the higher the costs in the form of the management fee. This is another reason why you should limit your investments to common indices as far as possible.

The type of income used

Equity ETFs regularly receive dividends from the companies whose stocks they hold. Bond ETFs receive interest payments from the issuers of the bonds they hold. Like other mutual funds, ETFs differ in what they do with that income. There are basically two options:

  • pour out or
  • reinvest.

Distributing ETFs pass on dividends and interest directly to investors once a year. The money is then posted to the investor's account. He then has to decide what to do with it. If you want to reinvest the distributed funds directly, costs can arise - for example through stock exchange fees.

Accumulating ETFs on the other hand, they reinvest the funds they have received in stocks or bonds. Interest and dividends are reflected in higher share prices. So the money stays in the fund and investors don't have to worry about reinvesting them. However, they also have no current income.

Distribution and accumulation ETFs can also differ in their tax treatment. If you want to be sure about this, you should ask your tax advisor.

The fund volume

A simple rule applies to this criterion: a fund should not be too small. Because: The lower the assets managed in an ETF, the greater the risk that the fund company will eventually close the fund. While this is not a catastrophe, it can create additional costs for reinvestment of funds.

Larger providers have an advantage in this regard because their funds often also manage more funds. And widespread indices are once again better than exotic ones.

You should therefore always find out in advance how large the volume of the index fund is in which you want to invest. You should also note that the securities from widely used indices are traded significantly more than those from exotic indices.

Building the Fund

ETFs track indices in three main ways:

  1. Either they actually hold all stocks in an index directly - in the same proportion as they are represented in the index. This procedure is called full replication (Replica). It is usually not offered because full replication is expensive, especially for very large indices that also contain many smaller stocks.
  2. Most of the funds contain only a part of the stocks in the index, supplemented by some derivatives. Then one speaks of one "optimized" replica.
  3. The 3rd important procedure is that synthetic replication. An ETF directly holds any securities that have nothing to do with the index and concludes a contract (swap agreement) with a bank at the same time. In it, it undertakes to compensate for the differences between the performance of the index and the securities basket held by the fund.

You will find detailed explanations of the various index mapping procedures in the text "How does an ETF replicate an index?".

This content was created by the joint editorial team in cooperation with the consumer advice centers in Baden-W├╝rttemberg and North Rhine-Westphalia for the network of consumer advice centers in Germany.