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Your Investment Options: A Breakdown of ETFs

Knowing how to secure your financial well-being is perhaps the most important skill you will need to learn before retirement. Simply saving your money in a savings account is not enough. Making your hard-earned savings work harder for you can make a huge difference in securing your retirement.

For instance, it will take around 36 years for you to double your capital in a 2% interest savings account. However, if you had invested in an investment that returns around 6% each year, you would have doubled your money in 12 years. That’s the beauty of compounding returns. In 36 years, your money would have grown by 800%.

But where do we start to invest? Which investment vehicle has an excellent risk-reward profile? To answer these questions, I have begun a series of articles detailing each investment option available to new investors. My first two articles looked at stocks and real estate investment trusts (REITs). In this article, I will focus on exchange-traded funds.

What are exchange-traded funds?

An exchange-traded fund, or ETF, is an investment fund listed and traded on the stock exchange. ETFs are passively managed funds that track a stock, bond or even a REIT index. As such, they seek to produce returns that mirror the performance of the index that they track.

Because ETFs are passively managed, they have lower management fees than actively managed funds. Therefore, more of the profits can be filtered down to investors.

In Singapore, investors have the option of buying ETFs that track the Straits Times Index (SGX: ^STI), S&P 500 index or even some that track the overall performance of REITs in Singapore.

Examples of ETFs

Investors can invest in Straits Times Index, which is a commonly used barometer of the Singapore market. The index includes 30 large-cap companies across a wide array of industries. These include banks, telecommunications, oil and gas, property developers, REITs, commodity producers and others. The SPDR STI ETF (SGX: ES3) and Nikko AM STI ETF (SGX: G3B) are two ETFs that track the performance of the Straits Times Index.

There are also REIT ETFs that track the performance of REITs. Lion-Phillip S-REIT ETF (SGX: CLR) tracks the performance of REITs in Singapore. It tracks the Morningstar Singapore REIT Yield Focus Index.

Phillip APAC SGX REIT ETF (SGX: BYJ) (SGX: BYI) uses a smart beta strategy to rank and weigh the underlying REITs according to total dividends, hoping to enhance the returns of traditional market-cap weighted ETFs.

The Nikko AM Straits Trading Asia ex-Japan REIT ETF (SGX: CFA) is another REIT ETF that tracks the performance of a REIT index.

Each REIT ETF has different constituent REITs and different weighting on each REIT, providing differing returns.

Investors can also buy ETFs that track overseas stock indexes like the SDPR S&P 500 ETF (SGX: S27), that tracks the S&P 500 index, or the United SSE 50 China ETF (SGX: JK8), that tracks China’s SSE 50 index.

Advantages

  • Cost-effective: As mentioned earlier, ETFs are passively managed, and hence, charge lower management fees than actively managed funds.
  • Diversification: When you invest in an ETF, you are essentially investing in a basket of stocks or REITs. As such, your portfolio is already automatically diversified through investing in an ETF.

Disadvantages and risks

  • Capital risk: As with all investments, your capital is at risk if the value of the index drops.
  • Tracking error: It is also possible that an ETF may not perfectly mirror the returns of the stock market index. As a result, your investment performance may not always reflect the index you wish to track.

The Foolish bottom line

Warren Buffett believes that investing in passively managed funds, such as an ETF, will produce greater returns than actively managed funds due to the former’s lower management fees. He is certainly not wrong as more than 70% of actively managed funds cannot beat the index that they are measured against. ETFs also provide investors with diversification, stability and income through dividends.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Jeremy Chia doesn’t own shares in any companies mentioned.