ETF Investing is one of the most misunderstood investment strategies. It was created with good intentions but was misused by many people to sell their products and services. At the surface level, they give you some investment advice that seemed to make sense. The typical pitch goes like these:
- You should buy the ETF because passive investing beats active investing in the long run.
- You should buy the ETF because it is cheaper than a unit trust, where you have to pay 5% in sales charges and 1.5% in management fees.
- Your financial adviser won’t recommend the ETF because their income depends on the use of high-cost active funds.
ETF investing is good, but it doesn’t mean you should blindly buy and hold ETFs. These claims are often repeated by people without verifying if it is true in the first place or whether they are even repeating the claims correctly.
What I will discuss in this article may be contradictory to what you hear or believe, but if you keep an open mind, you may find some new perspectives. Since most of the readers of this blog are Singaporeans, I will use the popular STI ETF as an example
What exactly is the STI ETF?
The “STI ETF” refers to the Straits Times Index Exchange Traded Fund. There are two components of this:
- The STI or Straits Times Index is the capital-weighted average return of the stocks of the top 30 bluechip companies listed in the SGX (Singapore’s Stock Exchange).
- An Exchange Traded Fund implies that this is a fund (not a stock) traded in the exchange.
You may buy an STI ETF when you want to hold a basket of Singapore blue-chip stocks such as DBS, Singtel, Keppel Corporation, etc. Instead of buying each stock separately, you can meet the same goal (at a lower cost) by just purchasing one financial instrument, the ETF.
If you want to find out more, you can read this article from Seedly about the benefits of the STI ETF and how to buy it as a retail investor.
You need to note that the STI ETF is a fund managed by a fund manager. It’s not true that you don’t have to pay the fund manager fee when you purchase an ETF. In fact, ETFs are often managed by active fund managers.
Now you have some basic understanding of STI ETF. Let’s look into the three myths of STI ETF investing.
Myth #1: STI ETF Investing is Passive Investing
Many people wrongly associate ETF investing with passive investing. A typical passive investing strategy involves two steps:
- Select and buy a low-cost fund which tracks the market.
- Do nothing for the next 10 to 20 years.
The first step is easy to do. The second step is not. In fact, long-term investing is psychologically and practically challenging to most retail investors.
Even if you believe you are up to the challenge to be a long-term investor, ETF investing is not the pure form of passive investing.
The concept behind passive investing is to take the “market return”, i.e. an average return of all the stocks. In theory, you get the median performance of all the stocks in the “market”. The challenge here is, how do you choose a “market”?
There are more than 4,000 ETFs in the world and the number of ETFs is ever-increasing. Each ETF tracks a “market”.
Here is a more detailed article to help you understand the “market”. The fact is that most ETFs are actively managed funds in the clothing of passive investing. How do you choose the right ETF?
If you want to start with ETF Investing, why would you even choose the STI ETF? Why is STI ETF better than S&P 500 ETF or MSCI World Index ETF? By claiming the STI ETF is a good option, you are already making an active investment decision.
No matter which ETF you choose, you are still essentially picking stocks unintentionally. Your ETF manager is trading stocks actively every day to make sure the fund behaves similarly to the market that they track. Your intention of passively putting $1,000 into the STI ETF has resulted in active buy and sell transactions of the underlying stocks.
In a nutshell, any ETF is just an instrument, not a passive investing strategy.
Myth #2: STI ETF Investing is Always Cheaper Than a Unit Trust
To understand this part, we need to step back and look at the history of ETF investing.
The idea of passive investing became popular after the global financial crisis in 2008. This was when many investors lost money and lost faith in the financial system.
Before that, people entrusted their money to insurance companies, banks and fund managers who often charged exorbitant fees.
I remember when I started managing wealth, any China fund or India fund easily made 50% a year and the consumers were happily paying the bank 5% sales charge and layers and layers of fees to an investment-linked insurance product.
But since the stock market was good and most people made money, investors did not complain much about the fees. They focused on performance.
With the advance of technology, sloppy stock market and disintermediation, things changed fast. Nowadays, the banks are charging an average of 2% sales charge. But even so, you can easily get a 0% sales charge with most of the independent investment platforms such as Fundsupermart and Poems, Even a platform like dollarDex which is operated by insurer Aviva applies zero sales commissions for unit trusts.
If someone is still claiming that it costs 3% to 5% to buy a unit trust, he is not telling the truth. Or if you are still paying those kind of charges, you have nobody to blame but yourself.
When comparing the cost to buy ETFs versus Unit Trusts, you are often misled. What the ETF industry has done well is to “externalize” the fees. For example, the ETF management fee may seem low, but are you aware of the brokerage commission, SGX clearance fee, custodian fees and bid-offer spread that you have to pay? If you have to pay $25 to buy $1,000 STI ETF, aren’t you actually paying a 2.5% commission?
But these are the small fees to pay.
Besides the STI ETF, most of the other ETFs that Singaporeans can buy are transacted in USD. Every time you convert your hard-earned Singapore Dollars to USD, you are subject to the bank’s commission and foreign exchange spread (often 2%). You will also be subject to currency risk when the USD depreciates against the SGD.
However, when it comes to unit trusts, you have a range of choices as well as effective hedging of the currency risk within the fund itself.
As an investor, your objective is to maximize your wealth, minimizing fees has its place, but it often has an insignificant effect.
Myth #3: Financial Advisers Do Not Recommend STI ETF Investing Because They Earn More To Sell Unit Trusts
Very often, my clients ask me if they should allocate some money into the STI ETF as “many people say the STI ETF is cheap and good”.
Let’s go back to the basics. The purpose of STI ETF is to track the Straits Times index. Does the STI Index return has any meaning to you? No!
The index doesn’t care about your retirement goals, it doesn’t care about your risk profile, it doesn’t care whether you can sleep peacefully or not. The index represents the market, and the market is TGH (The Great Humiliator) as Kenneth Fisher put it in his famous book “The Only Three Questions That Still Count”.
It is also a myth that financial advisers don’t recommend the STI ETF because they earn nothing. ETF was simply not available in the old days. Below are two STI ETFs:
- Spdr STI ETF was first introduced in 2002 (without much traction of course).
- Nikko STI ETF was only listed in 2009.
Nowadays, a financial adviser doesn’t earn a commission from selling funds, since you can buy it on your own at zero cost anyway. In Singapore’s context, a good financial adviser (who specializes in portfolio management) earns a “wrap fee” by doing asset allocations for you using the right instruments. You want to put your money where it makes money.
Do I recommend my clients to invest in the market through an index fund? Of course.
But if you can buy and sell a unit trust at zero cost today, I would argue an SGD denominated index fund is more cost-effective to use in Singapore than an ETF.
Just because a unit trust is called a fund doesn’t mean that it has to be actively managed. For example, I often use Singapore registered index funds for my client’s asset allocation. Let me name a few:
- Infinity Global Stock Index Fund
- Infinity S&P 500 Index Fund
- Infinity European Stock Index Fund
It is a shame that we only have 3 index funds in Singapore simply because the market is too small, but we can make do with it by choosing the right fund (at zero cost of course).
Allow me to summarize here.
The STI ETF is a good investment option, but it is not the only option for retail investors.
It’s perfectly fine if you believe in passive investing as an investing strategy, but you probably need to redefine what is “passive”. On the other hand, you should learn more about the importance of asset allocation than blindly putting your faith to ETFs.
If you trace the research source about ETF investing, most of them are referring to the US market and there is a reason why it worked there. In Singapore’s context, the ETF is still relatively expensive and inaccessible.
Just like the ETF product, new financial instruments and resources are available to retail investors from time to time. Keep yourself informed and keep an open mind when it comes to investing. If you’d rather engage professional help to manage your investment, click here to check out my investment management service.
I am sure you have some opinions on this, why not leave your comment below and let’s take this discussion further.