High fees in traditional Mutual Funds and the difficulty of diversifying risk within a stock portfolio have driven the boom of investment mechanisms such as ETFs, or "Exchange Traded Funds."
ETFs are a fundamental instrument for the individual investor seeking to enter financial markets and gain passive exposure. By automatically replicating an index, sector, or a basket of positions, the costs associated with active fund management are significantly reduced.
TER: Management Fees Matter
Just as with traditional funds, management expenses are critical. While an ETF replicates an index at a very low cost by avoiding active management, this does not mean the cost is irrelevant in the long run.
We must pay close attention to the Total Expense Ratio (TER), particularly when dealing with niche sector ETFs or assets with little competition. We must not forget that behind every ETF is a management company looking to turn a profit; their margin is derived precisely from factors that make the fund unique—be it convenience, accessibility, transparency, or security.
Fund Size is Not Trivial in the Long Term
ETFs offer multiple utilities: from replicating the broad market to compounding over the long term via Dollar Cost Averaging (DCA). However, they can also be useful in the medium term to provide exposure to a specific sector poised for outperformance, or even to follow market trends through leveraged or short positions.
A key aspect, especially for long-term investing, is the instrument's liquidity, its longevity, and whether it meets the provider's objectives. You want to avoid being stuck in a position that must be liquidated prematurely because the provider decides to merge it with another ETF. This is common in Mutual Funds and forces the investor to realize gains, pay taxes, and search for a new investment vehicle.
Hedge or No Hedge: Flexibility in Risk Protection
When investing in foreign assets denominated in another currency, you incur an additional risk: the fluctuation of that currency’s value against your base currency. A Hedged ETF allows you to mitigate this risk, simplifying the investment decision.
However, keep in mind that the risk is never 100% covered. While you hedge against relative devaluation, the underlying company’s operations may still be implicitly affected if it relies on foreign economies. You must evaluate whether the extra commission justifies the protection provided in that specific scenario, as these fees can sometimes be excessive for the level of protection offered.
Inverse and Leveraged ETFs: Seizing Opportunities
Another growing segment is Inverse ETFs, which replicate the opposite move of an index—useful for short-term plays to protect a portfolio from corrections or bear markets. Additionally, there are Leveraged ETFs that multiply volatility, allowing for amplified gains (and losses!) when capitalizing on high-price-variation events.
This category is perhaps the most dangerous for an individual investor's portfolio. The move must be clear and short-term; otherwise, you risk losing a significant portion of your capital due to the high fees and the structural complexity of these instruments.
Finding the Right ETF for Your Strategy
Once these characteristics are understood, we can focus on the most important part: deciding what to incorporate into your strategy.
A great resource for this is JustETF, a site that allows you to filter through most ETFs available in Europe. Note that European investors generally cannot invest in US-domiciled ETFs directly due to the MiFID II directive.
I have selected several relevant and useful options for a long-term investor:
- Invesco S&P 500 UCITS ETF (SPXS.AS) – TER: 0,05% – Accumulating (No Dividends) – Euro
- Invesco S&P 500 UCITS ETF Dist (SPXD.SW) – TER: 0,05% – Distributing (Dividends) – Euro
- Vanguard S&P 500 UCITS ETF (VUAA.L) – TER: 0,07% – Accumulating (No Dividends) – USD
- Vanguard S&P 500 UCITS ETF Dist (VUSA.AS) – TER: 0,07% – Distributing (Dividends) – Euro (Dividends in USD)
