Stop Wasting Money on ETFs
When it comes to what some would consider “traditional” investing, the two main options are stocks and bonds. Stocks come in a variety of forms such as individual stocks or as part of a collection of stocks like mutual funds, ETFs, or index funds. ETF stands for exchange-traded fund and they are essentially a fund consisting of a collection of stocks. So instead of buying 10 shares of Microsoft and 10 shares of Apple, an investor can buy a few shares of, for instance, an S&P 500 ETF, approximately 14.5 percent of which consists of Apple and Microsoft. The benefit for investors is that ETFs offer an easy way of increase their diversification and, by extension, lowering the risk of their overall investment portfolio. It is easier and, in some senses, cheaper to buy a share of an ETF that consists of 100 stocks than buying one share each of 100 stocks. That said, the tradeoff of ETFs as opposed to individual stocks is the lower profit ceiling in that if an investor spent 10,000 dollars on Microsoft stock and another investor invested 10,000 dollars in an ETF of which a large percentage consists of Microsoft stock, in the event the stock significantly increases in value, the investor that invested directly in Microsoft would have a higher rate of return and overall profit.
When it comes to picking which ETFs to invest in there are several potential starting points and ideas to consider. Historical performance statistics are often a good place to start in terms of both comparing ETFs as well as finding ETFs in the first place. While ETFs with astronomical rates of return can be enticing, it is worth investigating the time period over which the ETF had that rate of return as unpredictable events or factors (global pandemics, war, inflation, supply chain issues, etc.) can significantly increase the value of a given ETF but may not necessarily occur again or may not occur for many years. It is worth noting that while historical performance data is very useful it is in no way a guarantee of future performance. Another option is starting with a stock you want to invest in and using tools like ETF.com to find ETFs that have that stock as a part of the overall fund.
In the world of finance and investing there are very few, if any guarantees. However, for some ETFs there is an easy way save or make (depending on how you look at it) more money. While there is a large variety of ETFs, there are instances in which multiple ETFs follow the same stock index, like the S&P 500. For those unfamiliar, the S&P 500 tracks the stock performance of 500 of the largest companies on United States stock exchanges. The money saving or wasting potential with ETFs that follow the same stock index arises in the form of the expense ratio. The expense ratio is basically the percent you pay as an investor in fees to whoever controls the ETF. If the expense ratio is .1% and you invest 10,000 thousand dollars one year, your expenses for that year will be 100 dollars. It may surprise you to learn that while multiple ETFs follow the same index, they do not necessarily have the same expense ratio. As such, investors may be overpaying for what is essentially the same ETF.
Let’s take an example and look at how the math breaks down. As with many things in investing, time is one of your greatest assets and causes small differences to increase in significance and impact.
If you invested 10,000 dollars into the following three S&P 500 ETFs on January 1st, 2013, this is how much it would be worth as of July 5th, 2023:
SPY - 38,478.85
IVV - 38,725.39
VOO - 38,732.90
A one-time investment in SPY instead of VOO loses the investor 254.05 dollars due to the higher expense ratio. One aspect worth keeping in mind, which explains why the differences in value is not as big as you may have expected, is that this is simply a one-time 10,000 dollar investment where an active long-term investor would likely be continually purchasing shares of the ETF and reinvesting profits, increasing both their overall investment and the difference between the net profits. Also 10,000 dollars and 10 years depending on your investing approach, goals, and financial standing, may be a short period of time and small investment
Let’s increase the initial investment and timeline to get a better idea of the impact in what may seem like a small percentage difference in expense ratios. For a 20,000 dollar investment on January 1st, 2000 until July 8th, 2023, the investment would be worth:
SPY - 91,885.562
IVV - 98,040.85
Just by increasing the initial investment by 10,000 dollars and the investment timeline by 13 years, increases the difference in profit to 6,155 dollars and 29 cents.
Because the SPY ETF was not made until 1993, we cannot compare the performance of SPY and IVV over a 40-year period. As an alternative substitute, we can just increase the initial investment to 50,000 dollars. I am not saying increasing the initial investment from 20,000 dollars to 50,000 dollars would result in an ending value similar to an initial investment over a 40-year timeline, this simply serves as an example using the available data. For a 50,000 dollar investment on January 1st, 2000 to July 8th, 2023, the investment would be worth:
SPY - 229,713.89
IVV - 245,102.13
This results in a difference in profits of 15,388 dollars and 24 cents with only a difference of .065 in expense ratios.
Due to how compounding investments work, over years and decades, the difference in expense ratio will grow in impact and significance.
Using a different example and to demonstrate the impact of initial investment size instead of the investment timeline, investing 100,000 dollars in QQQ and QQQM on January 1st, 2020 results in the following values as of July 8th, 2023:
QQQ - 245,102.13
QQQM - 131,049.21
As a final example, let’s compare two Russell 2000 ETFs. For a 20,000-dollar investment on January 1st, 2010 to July 8th, 2023, the investment would be worth:
IWM - 178,310.78
VTWO - 163,448.75
This results in a difference in profits of 14,862 dollars and 3 cents with only a difference of .09% in expense ratios.
Below is a brief overview of the expense ratios for duplicate ETFS, for reference:
IVV - .03%
VOO - .03%
SPY - .095%
QQQM - .15%
QQQ - .20%
IWM - .19%
VTWO - .08%
Ultimately, ETFs provide investors with an easy way to increase their investment diversification without spending significant amounts of time investigating hundreds of stocks. While the expense ratio is not the only factor to consider while evaluating and comparing potential ETF investments, it is certainly one worth checking as it could save you a significant amount of money on long-term investments.