How to select an ETF - the basic criteria to pick one

In a previous blog post, we covered the basics of an ETF. Now I want to share a bit more of what I look at when selecting an ETF to invest in. When I started, even though I had a rough idea of the basics, I was quite undisciplined - and you can still see the effect on the portfolio I have today, where I have a long tail of small ETF investments. 


Now I like to think I am a bit more analytical on my choices and have defined the list of ETFs that I want to keep interesting for the future. The criteria below helped me a lot in that process.


Your idea or objective.

Probably the most difficult question overall - what strategy do you want to follow and how does this ETF fit into that?

If you are looking for just one ETF, then look for something covering the full world (search VWCE or VWRL) . Are you looking to cover just a specific Geography? The search function on www.justetf.com is your friend!

Or do you want to bet on a specific sector / theme? Same as above. 

Maybe you are getting closer to your RE moment and you want to diversify your equity portfolio with different asset classes - e.g. bonds. 

It might be a no brainer for most, but without a clear idea of what you want to achieve, you are going to shoot in the dark in all directions. 


Accumulating vs Distributing: everyone loves dividends - your national tax authority too.

You hear a lot around divident investing, divident yield, ect - and for good reasons: everyone likes to have a constant stream of cash in his or her bank account every month. Somehow, it is reassuring to see the money coming in, it means you are doing something right. 

The problem is that - in most EU countries - you are paying more taxes than if you had an Accumulating comparable ETF (I live in the Netherlands where it does not matter, but this is one of the few exceptions as far as I know). Also, if you are going to reinvest the dividends on your own, you are likely to pay transaction fees - this effect should be quite small though. 


As general recommendation, if you are still in the accumulating phase of your FIRE plan - accumulating ETFs will serve your purposes better than Distributing ones, however you can still go for the alternative option and be perfectly fine. If you are enjoying your well deserved early retirement, Distributing ETFs are not burdened by this disadvantage anymore (if you sell your ETFs you will pay a capital gain tax anyway). 


For an overview of dividend tax rates in Europe, I found this website - I cannot really vouch for the accuracy though. 


Size Matters.

We can kid ourselves as much as we want - but size matters. Why take a risk with a fund size below 100 mln Euro? If the fund size is very small, you might face liquidity problems, a high bid-ask spread or maybe the fund will even close (dont worry, you will get your money back - but why going through the hassle?).


Cheaper is better.

Ceteris paribus (fancy Latin for saying - All other things equal), you want to pay as little cost as possible on your ETF. 

The key aspect to consider here is the TER (Total Expense Ratio). If you find a comparable ETF with a lower TER, in some cases it might even be worth to sell your current ETF, pay the capital gain tax and buy the cheaper ETF. This could pay off in the long run - so if you have a shorter time horizon, probably it is not worth exploring it.


Replication Method - KISS (Keep It Simple Stupid).

I keep it simple here - and avoid what I do not understand. Physical replication, whether full or sampled, is my personal choice. I avoid on purpose everything Synthetic - apparently they offer some advantages in terms of returns vs Physical ETFs but they also tend to have higher costs (TER).


Look for an Irish or Luxemburg domicile.

At first I was not paying a lot of attention to this, but you will pay less taxes if you do - especially if you go for the Irish one. When you search for an ETF, look at the ISIN and check the first letters: IE for Ireland or LU for Luxembourg. 

Both countries have several tax treaties which can reduce your overal taxation.


And that is basically it! I am sure there are sophisticated criteria to consider, but I believe that for the "ordinary" average investor this would be enough in 90% of the cases!

Write a comment

Comments: 0