When we first started investing in ETFs, we were shocked by the range of returns. Some ETFs seemed to consistently outperform others by a wide margin. Why was that?
As it turns out, the average return of an ETF depends on a multitude of factors. The type of assets it holds, the geographic region it covers, and even the specific time period you're looking at all play a role.
In this article, we'll help you understand what returns you can realistically expect from different types of ETFs, and share some strategies to potentially boost your investment performance.
Average return on the very long term (1900-2023)
In their Guide to the Markets, JP Morgan calculated that US stocks have returned about 6.7% per year on average between 1900 and 2023. This is real return, so it takes into account inflation. Bonds have returned 1.8% per year, and the savings account a meagre 0.5% per year.
Diversified index-based ETFs are meant to track the entire stock market. So these numbers are a good estimate for the long-term returns you could have expected to earn for the past 120 years when investing in a world ETF.
They highlight the differences in performance between stocks, bonds and your savings account. Someone who had invested $1 in 1900 would have $3,230 in 2023 if he had invested in equities, $9 in the case of bonds and only $2 if they had left it on their savings account.
Average returns of popular ETFs
Unfortunately, there is no data available that goes back that far in time for the ETFs we invest in today. So we have to look at a shorter time period. Using Backtest, we can simulate the past performance of any ETF.
We compared the past performance of the last 32 years between 1992 and 2024 of three popular ETFs:
- IWDA, an ETF by iShares that tracks the MSCI World index (IE00B4L5Y983)
- SPYL, an ETF by SPDR that tracks the S&P 500 index (IE000XZSV718)
- IGLA, an ETF by iShares that tracks the FTSE World Government Bond G7 index, meaning it invests in a collection of government bonds (IE00BYZ28V50)
There are clear differences in performance:
The average yearly returns are as follows:
The S&P 500 ETF had the highest return. Over the last 30 years, the S&P 500 index has delivered an average yearly return of 11.0%. The American stock market has outperformed the rest of the world these last few decades. Beware though, it doesn't mean it will continue to do so over the next decades.
More generally, whether we invest in stocks or bonds significantly impacts the return a lot.
The type of asset impacts the return
Both SPYL and IWDA are ETFs that invest in stocks. Stocks are the main drivers for returns. Throughout the decades, companies all over the world have continued to innovate and thereby yield solid gains to their investors. However, there's no free lunch in investing. Higher returns always come with higher risk. In the world of finance, this risk translates to greater fluctuations in the prices of stocks. They can go up and down very quickly, sometimes as much as 45% in a good year like 1999, but also as low as -40% during a "once in a lifetime" crisis like in 2008. In finance jargon, we say that stocks are highly volatile.
Whereas stocks are very exciting (and scary when they sharply drop), bonds are very boring. They don't fluctuate as much. But that means their returns are lower, as we saw in the case of the bond ETF IGLA compared to the stock ETFs SPYL and IWDA.
When building our portfolio of ETFs, we can use the ratio between stocks and bonds to calibrate the expected return (and risk) of the portfolio. More stocks and less bonds means a higher return and higher volatility. More bonds and less stocks will have the opposite effect.
We can see this visually by backtesting three portfolios of ETFs composed of:
- 100% stocks
- 50% stocks and 50% bonds
- 100% bonds
The portfolio with only stocks fluctuates the most. But on the long term, it also yields the highest return. In contract, the portfolio with only bonds is more stable, and delivers a much lower return by the end.
How to increase the return of your ETF portfolio
To improve the return of your portfolio of ETFs, there are a few things you can do:
- Invest more in stock ETFs
- Choose cheaper ETFs
- Choose accumulating ETFs to benefit from compounding
- Minimise broker fees
Invest more in stock ETFs
We already saw that stocks are the drivers of return. By increasing the allocation of your portfolio to ETFs that invest in stocks, you can increase the expected return of your portfolio. Beware that it will likely also make your portfolio more volatile. So make sure you'll still be able to sleep at night! Or worse, do not make your portfolio so volatile that you run the danger of selling your entire portfolio during an impulsive panic.
Choose cheaper ETFs
For most indexes, there are several ETFs that track the index. For instance, there are 27 S&P 500 ETFs in Europe. The cost of an ETF is measured by its total expense ratio, a yearly percentage on the total amount invested. When having the choice between several ETFs that are equal in other criteria, opt for the cheaper one. The price difference will result in a slightly higher return in the long run.
Choose accumulating ETFs
Accumulating ETFs directly reinvest their dividends in the fund, whereas distributing ETFs pay out the dividend to you. Accumulating ETFs grow faster than their distributing equivalent, because the reinvested dividends compound over time.
Minimise broker fees
ETFs are bought and sold on a stock exchange. You need an account with a broker to access a stock exchange. Every time you buy or sell an ETF, the broker takes a commission, the broker fee. The less you spend on fees, the higher your return will be. But beware that cost is only one of the many criteria to choose a broker.
Conclusion
We've seen how the composition of your ETF portfolio can dramatically affect your long-term returns. While stocks have historically provided higher returns, they also come with greater volatility. Bonds, on the other hand, offer more stability but lower growth potential. The key is finding the right mix that aligns with your financial goals and risk tolerance.
To optimise your portfolio's performance, consider increasing your stock allocation, choosing low-cost ETFs, opting for accumulating funds, and minimising transaction fees. However, remember that investing is a personal journey, and what works for one person may not be suitable for another.
If you're looking for a simpler way to invest in a diversified ETF portfolio, have a look at Curvo. We've designed our app to take the guesswork out of investing, helping you build a portfolio that's right for you. Take the next step in your investment journey and see how Curvo can help you work towards your financial goals.