What you should know about ETFs
It is always great to start on a lighter note, that note being that the advantages of investing in ETFs are their affordability, transparency and that they are liquid. There are now many providers who include ETFs (Exchange Trade Funds) in their portfolio and demand is constantly growing.
If you are someone who prefers steering their own wheel then investing in EFTs is for you because they give you that control over your finances. Let us let you into the realm of ETFs what to know, from disadvantages, to advantages and handy tips.
What are ETFs?
ETFs are securities that are traded on the stock exchange like shares. They can be bought and sold at any time. The course changes daily.
With ETFs, you invest in a basket of securities. You can achieve broad diversification in a very simple and inexpensive way.
That is the advantage of ETFs. They replicate the underlying index 1 to 1. You can avoid having to pay an expensive fund manager. So the fees go down. One important thing worth noting is that ETFs fully follow the fluctuations in the value of the index. Choosing the right index cannot be understated.
Both index funds and ETFs share a closely similar indexing architecture, the difference is that you can buy and sell ETFs in one day at any time during the stock market. This is not possible with index funds because they are not traded on the stock exchange. Your flexibility is limited to only buying and selling once a day through the fund provider. To find out more about the differences and similarities of ETFs and index funds, Investopedia offers more details.
It would be too good to be true if investing in ETFs only offered us green flags, while it is a great investment option, there are a few disadvantages. Here is what we have to say:
Advantages of ETFs
- You can invest small amounts.
- ETFs are cost-effective if you invest yourself. Nonetheless, remember that there are still costs. These can be costs of the provider itself or brokerage fees for buying and selling or even costs for the portfolio itself. You can calculate the investment yourself using a calculator.
- ETFs are quite transparent. You can easily see how your money is invested, usually at least the largest positions
- When you invest in ETFs, you have flexibility. If you need the money or notice that the investment is not working for you, you can always sell or buy, depending on what you want.
- ETFs are special funds. This means that you have protection if the investment company goes bankrupt.
Disadvantages of ETFs
- Investing in ETFs is subject to certain risks. In addition to the risks of value fluctuations, there are also tracking error risks and currency risks. Tracking error risks are deviation risks that always exist between the benchmark and the portfolio.
- Return: The ETFs are tied to the index. Therefore, they cannot achieve a better return than the index it tracks.
- You’re a little limited. With ETFs there is no option for you to exclude individual companies. So if you have certain topics that interest you and that you feel are important, you cannot always address them. We’re just saying sustainability here, for example
- You have less say in ETFs than if you invest in individual stocks. For example, you don’t attend the general meeting once a year
What should you know about ETFs and taxes?
Both dividend and interest income are subject to income tax in Switzerland. The amount you have invested is subject to wealth tax. It is important to know that this also applies if you use the income to reinvest it. Income from investing in ETFs is subject to withholding tax of 35 percent in Switzerland. However, you can reclaim the withholding tax if you are resident in Switzerland.
The purchase and sale of ETFs is also subject to stamp duty. It is 0.075 percent for Swiss funds and 0.15 for foreign funds. If you make a lot of purchases and contracts, this is a factor that you need to take into account. If you would like to make a deep dive into the taxation of your investments, check out our article about the peculiarities of Switzerland’s tax system.
1. Create your investment strategy
This is all based on your risk threshold, how risk tolerant are you? This means you can diversify the various investments and, for example, invest in stocks and bonds. Switzerland has a huge catalog of ETFs. They offer you great diversification as they allow you to invest in a variety of asset classes, markets and currencies.
2. Choose your index
As pointed out earlier, ETFs completely follow the fluctuations in the value of the index. This is why it is highly imperative that you choose the right index for you. It is best to look at how the index has performed in the past.
3. Check the imaging quality
It is not necessarily the case that the return of the ETFs corresponds one-to-one to the return of the benchmark. The fact is that there can be differences in returns of several percentage points per year. It is worth looking at the returns of ETFs and indexes. If possible, they should not differ too much from each other.
4. Choose the replication type
This refers to the reflection of an index by an EFT. A distinction is made between physical and synthetic replication. With physical replication, the ETF invests in the securities included in the index. It is considered to be less risky. Synthetic replication is more complicated and less transparent because it works via derivatives.
5. Compare the costs per year
Here the TER is important for total costs. It includes costs for advertising and distribution, including administration fees. However, transaction fees are not included here.
6. Optimise your trading costs and taxes
It is important to note where the fund domicile is. It can impact your returns from a tax perspective. Investing in ETFs can come with various costs. Be mindful of that as they can be very important, especially for investors who buy and sell a lot.
