How to Choose an ETF: 3 Common Choices

A Look at the Markets: October Performance

Let’s look at how the FTSE all-world ETF and Bitcoin have performed in October.

The Vanguard FTSE all-world index closed almost flat (same price at the end of the month as at the beginning) in October 2024 with a tiny 0.2% increase.

The green candle second from the right shows Bitcoin’s performance in October 2024 of just under 11%.

The last candle is November’s unfinished candle which shows a positive reaction to Trump’s reelection as the 47th President of the USA. It is too early to see if this going to be sustained so we will revisit this next week.

Comparing S&P 500, Developed World, and Global ETFs to grow your portfolio

Last week’s newsletter discussed determining the retirement portfolio size needed to generate an income of 4% or more, or conservatively, 2.5%. This week, we’ll explore an investment vehicle that could be a good fit for your portfolio - Exchange-Traded Funds (ETFs).

As I’ve mentioned in my previous newsletters, there are many ETFs available for investment. Today, I want to concentrate on three widely discussed general categories:

1. S&P 500

2. Developed World ETF

3. All World ETF (developed and emerging markets)

Total Expense Ratio (TER)

Before we begin, let me introduce you to the Total Expense Ratio (TER). The TER represents the cost associated with holding an ETF. Unlike an invoice, it’s not a direct expense that you have to pay. Instead, it subtracts from the value of the ETF, and you may not even realize it. While it’s important to consider the TER, it’s more crucial when comparing different providers, such as Vanguard and iShares, rather than comparing different categories, which tend to become more expensive as they become more complicated.

Where to start?

Over the past few years and even decades, the United States has consistently outperformed the rest of the world in terms of performance. There is a compelling argument that this trend will persist. Consider the companies that many of us use daily - Apple, Meta (Facebook, Instagram, WhatsApp, and so on), Microsoft, Amazon, and so forth.

But will this trend persist? I believe it very likely will. However, can I be absolutely certain of this over the decades that I intend to hold the ETF? No. Nevertheless, an S&P 500 ETF serves as a reliable starting point.

S&P 500

An S&P 500 ETF attempts to replicate the performance of the S&P 500 index, which comprises approximately 500 of the largest publicly traded companies in the United States.

Advantages:

1. Good recent performance

2. Typically lower TER

Disadvantages: 

Exposure to only one country - the USA.

For this reason, you may want to consider an ETF option with increased diversification, specifically in more countries.

Developed World ETF

A Developed World ETF usually invests in companies from approximately 23 developed countries. This significantly reduces the exposure to the United States. An S&P500 ETF may have around 95% exposure to the US whereas a developed world ETF may have around 66% exposure to the US. However, the actual percentage may vary slightly among different providers.

Note: The iShares Core MSCI World ETF is actually only a developed world ETF. Be careful with names! For instance, the Vanguard FTSE Developed World ETF is better named. Always check the holdings - I will show you how to do this next week.

Advantages: 

Increased diversification

Disadvantages:

1. Typically more expensive (higher TER)

2. Only 23 countries

3. No exposure to emerging markets

All-World ETFs (developed world and emerging markets)

What do you envision the world to look like in the next two decades, three decades, or even four decades? Throughout my lifetime, I’ve witnessed the economic rise of China. Will other emerging market countries like India, Mexico, Brazil, and perhaps others, also experience significant economic growth and emerge as global powers?

We may not know for sure, but I believe there’s a strong possibility. In light of this, if you’re looking for exposure to these countries, you might want to consider an all-world ETF. These ETFs usually have exposure to 23 developed world countries and around 24 emerging market countries.

The exposure to the United States will usually decrease to less than 60%.

Advantages:

Further diversification

Disadvantages: 

1. Typically more expensive (higher TER - more complicated to provide)

Here's the Magic

All these ETFs automatically adjust their holdings to reflect changes in the indexes they follow. For example, if a company in an S&P 500 ETF increases in market size, the ETF will update its holdings to account for this.

Similarly, if another developed country performs well, the developed world ETF would adjust its holdings to reflect that growth. Similarly, the all-world ETF would respond to the strong performance in emerging markets over the coming decades.

However, it’s important to note that the S&P 500 ETF is restricted to approximately 500 companies within the S&P 500 index, while the developed world ETF exclusively includes companies from developed countries. In contrast, the all-world ETF offers the most flexibility, allowing it to adjust its holdings without any geographic limitations.

Conclusion

Any of these options are worth investigating. If you are happy with an index mainly investing in companies you know, then an S&P 500 index is suitable and usually the cheapest (low TER). The chart above shows that an S&P 500 ETF has had the best performance over the last 5 years.

However, in five or ten years, if you notice emerging markets outperforming, how will you feel? Would you want to alter your investment strategy? You might need to consider tax implications when selling and reinvesting, but you could simply start investing in a new ETF. There’s nothing wrong with that.

However, if you’re looking for a truly ‘set and forget’ investment strategy, you might want to consider an all-world ETF from the outset. As shown in the chart, this ETF has performed the worst over the last 5 years.

The developed world ETF is suitable for investors who want more diversification than the USA but are uncomfortable with the potential increased risk of the emerging markets. Over the last 5 years, this ETF has performed better than the all-world ETF but not as well as the S&P 500 ETF.

As often is the case in investing, there’s no single, definitive answer, but here are some key factors to keep in mind.

Next week, we will look at some specific examples of ETFs in each of these categories and answer a newsletter reader's question.

Important Note: This newsletter provides general guidance only. Always consult a qualified financial advisor for personalized retirement planning advice.

Trump Wins the US Presidential Election

Donald Trump has won the Presidential Election in the United States and will become the 47th president of the USA.

How did the Markets React?

Markets like stability and, predictably, the S&P 500 reacted positively to a clear result.

Elon Musk, a prominent supporter of Trump, saw Tesla’s success after the election. He leveraged his platform, X (formerly Twitter), to actively promote Trump throughout the campaign.

The biggest long-term winner could well be Bitcoin. Trump has discussed the possibility of establishing a strategic Bitcoin reserve for the U.S. government and relaxing cryptocurrency regulations, which would mark a significant departure from current policy.

As I’ve mentioned in my previous newsletters, I’m seeking a weekly close of Bitcoin above $72,000 as a significant bullish signal. This week might be the one, and Trump’s victory could have been the catalyst.

If the new administration introduces a Bitcoin reserve, Coinbase could potentially serve as a custodian for it. Additionally, as a cryptocurrency exchange, Coinbase benefited from the higher cryptocurrency prices.

Will these moves be sustained or will they reverse? Time will tell.

We will look at other implications of Trump’s election victory, particularly in Europe, next week.

Word of the Day - Catalyst

Catalyst - noun - countable - chemistry - something that makes a chemical reaction happen more quickly

Catalyst - noun - countable - a condition, event or person that is the cause of an important change