When we first started investing in ETFs, we were overwhelmed by the choices. ISIN codes, domiciles, replication methods - it felt like learning a new language.
But as Belgian investors, we quickly realised that some factors were more important than others. The right choices could save us money on taxes and fees, while the wrong ones could eat into our returns.
To help you avoid the mistakes we made, we've put together a checklist of nine key things to look for in an ETF. Whether you're a beginner or an experienced investor, this guide will help you make better investment decisions.
Checklist to select an ETF
When investing in ETFs, it's important to get the details right to avoid unnecessary taxes, fees, and risks.
Belgian finfluencer Thomas Guenter popularised a checklist for what to look out for when choosing an ETF. Based on his work, we decided to share with you the criteria we use when selecting an ETF. Here's our checklist to help you decide which ETF is good for you as a Belgian investor:
Investment style: follow an index
Most ETFs are passive, meaning they track an index. But more and more active ETFs are appearing. But, these funds are more expensive and have the same problems as traditional active mutual funds. They often yield lower returns than an index-based ETF.
Type of asset: stocks or bonds?
When choosing your ETF, you need to pick the right asset class: stocks, bonds, or other type of investment. Each has a role in a portfolio. Stocks represent ownership in a company. They offer the potential for higher returns over time, but with more volatility and risk. Bonds are different. They are loans to corporations or governments. They provide predictable income through interest, which makes them less risky than stocks.
You will most likely want a portfolio that contains both stocks and bonds. The reason is that you want the risk of the portfolio to match your goals, appetite for risk and your capacity for taking risk. Also, as you get older and near your financial goal, you will want to reduce the risk of your portfolio.
Distribution of dividends: accumulating
You pay a 30% tax on any dividend you perceive. Distributing ETFs distribute their dividends, which means they're taxable. On the other hand, accumulating ETFs reinvest the dividends into the fund before you ever receive them. This way, you avoid the dividend tax.
Furthermore, accumulating ETFs are more in line with a passive approach. By automatically reinvesting the dividends, you leverage compounding interests.
That's why you should invest only in accumulating ETFs (unless you have a good reason not to).
Domicile: Luxembourg or Ireland
Luxembourg and Ireland have special tax treaties with the US. These treaties make it attractive to set up funds there because they'll have to pay less taxes. Which means you, as an investor in the fund, will have to pay less taxes. So invest in ETFs domiciled in either Luxembourg or Ireland.
You can tell the country of domicile from the ISIN code of the ETF. The ISINs of funds domiciled in Ireland start with "IE", those from Luxembourg start with "LU".
One such popular ETF is SPDR's MSCI World ETF. From its ISIN code IE00BFY0GT14 we can tell it's domiciled in Ireland.
Currency: traded in euro
You can avoid currency conversion fees by trading your ETFs in euro. For instance, we can see on justETF that the SPDR MSCI World ETF trades in USD and GBP on the London Stock Exchange. Your broker will likely charge a fee when it does the conversion for you. So instead, buy the ETFs in euro on for instance Euronext Amsterdam or XETRA.
Size: at least €100 million invested in the ETF
You want an investment that is viable for the long run. So, you want to avoid an ETF shutting down soon after your investment. Note that you do not lose your money when an ETF shuts down. You'll just receive the market value of the underlying investments. But you will have to find another ETF to invest in, which is an annoyance.
As ETFs must reach a certain size to become viable, a larger fund is less likely to shut down. Also, larger funds are easier to buy and sell because there are more players in the market. The spread between the buy and sale price is smaller. A guideline is to only consider ETFs with at least €100 million.
Replication: physical
Invest in funds that physically replicate their index. Some ETFs are cheaper through a technique called synthetic replication. The fund provider does not buy the index's companies' shares. Instead, they use financial engineering to replicate the index's returns. They do this by making a deal with a third-party, most often a large bank. It sounds a bit dodgy, and we think so too. The main issue with synthetic replication is that it adds risk coming from the counterparty. And when investing our life savings, we want to limit such risks. Avoid!
Cost: cheaper is better
Fund providers charge a fee for managing a fund. The total expense ratio (TER) indicates the total cost of a fund. It's a percentage on the total assets that you pay every year. For instance, SPDR MSCI World has a TER of 0.12%, meaning that if you have €100 invested, you will pay €0.12 every year to SPDR for managing the ETF.
When choosing between ETFs that follow the same index, we prefer the cheaper one (if the other criteria are the same). For instance, IWDA is an equivalent MSCI World ETF but managed by iShares. And at a TER of 0.20%, it's slightly more expensive.
Note that ETFs are significantly cheaper than the traditional active funds sold by your bank. As an example, this active fund from KBC costs 1.71% per year. That's an order of magnitude more expensive than both MSCI World ETFs! Cost is an important reason why ETFs have higher returns than traditional active funds.
Finally, don't fuss too much about small differences in TER. Even on the long run, the impact of an ETF with a TER of 0.15% compared to one with a TER of 0.12% will be minimal.
Transaction tax (TOB): registered in the EU but not in Belgium
In Belgium, there’s a tax on transactions ("beurstaks" or "taxe boursière" or TOB). You pay it every time you buy or sell a security. For ETFs, the tax rate varies between 0.12% and 1.32% of the transaction amount.
The countries where an ETF is registered impacts the tax rate. Accumulating ETFs that are registered in the European Union but not in Belgium have the lower 0.12% tax rate. Those registered in Belgium are taxed at the highest 1.32% rate. We know, it's weird. You'd expect an ETF closer to home have a lower tax rate.
You can find out the registered countries on the website of the fund provider.
Applying the checklist on SWRD
Let's use the checklist to assess a popular ETF, the SPDR MSCI World ETF (IE00BFY0GT14). The ETF tracks the MSCI World index and is more commonly known by its ticker SWRD.
To find out the characteristics of an ETF, we can go to the website of the fund provider. But it's easier to use justETF as it has all the ETFs available in Europe in one place. For SWRD, justETF tells us:
Let's see how it matches against our criteria:
As we can see, we've been able to identify the ETF as a good fit for a long-term investment!
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Conclusion
Choosing the right ETF for your investment journey can seem daunting, but with this checklist, you're now equipped to make informed decisions. Remember, it's not just about finding any ETF; it's about finding the one that aligns with your financial goals and risk tolerance.
As you've seen, sites like justETF are valuable tools in your research. However, if you're feeling overwhelmed by the process, or simply want a more hands-off approach, consider exploring automated solutions like Curvo. We've designed our app to take care of these complexities for you, ensuring your investments align with best practices and your personal financial objectives.
Ready to put your new knowledge into action? Start by reviewing your current investments or, if you're new to investing, take the first step towards building your financial future. Remember, the best investment strategy is one that you can stick to consistently over time.