ETFs are the 'Choose Your Own Adventure' of your portfolio
There's a series of children's books published from the 1970s through to the 1990s called Choose Your Own Adventure, and it's making a comeback.
I know this because my 12-year-old has just requested them and he's pretty good at anticipating future trends.
It's no surprise because he loves computer games, which are pretty much the modern equivalent of the Choose Your Own Adventure series.
The books subvert the theory that the author guides the reader through a series of adventures in a particular order.
Instead, the adventure is determined by the choices made by the reader as they advance through the book.
While they make the best choices they can, the results can be disastrous or wonderful.
They just don't know with any certainty.
Investing uncertainty
It's the same with investing!
Up until the past few years, many Australians invested in actively managed unit trusts.
Buying an actively managed fund was a lot like finding an old Wilbur Smith novel in a summer rental and spending two days on the back deck hunting lions and fighting mercenaries.
Every month, or every quarter, the portfolio manager writes an update describing the adventures they had with investors' money.
Sometimes it was a good adventure (they made money) and sometimes they had a bad adventure (they lost money).
The rise of ETFs
Over time investors became disheartened with both the adventures, the result and the cost.
The current iteration of the investors' Choose Your Own Adventure is in the field of exchange traded funds (ETFs). With ETFs, investors can choose their own investing adventure.
And they can play it however they like: fast and loose, cheap and cheerful, slow and steady. There's something for everyone.
Just consider the ETFs on offer.
In 2024, 49 products were added to the ETF market in Australia. Three of these were geared, offering around two times the potential returns of the underlying product. That's also two times the volatility and two times the potential loss.
Three of them were for investing in cryptocurrencies, offering a way for the crypto-curious to whet their appetite in the field without signing up for a crypto exchange or having a crypto wallet.
Many were equities products based on some smart beta concept, such as equal weighted, value, growth, momentum and quality.
A lot of the returns in popular active products come from these factors (I have tested it). Investors have realised they can have the same factors in their own portfolios but at a third of the cost or less.
New kids on the block
Some were what I call 'smart product' products.
These are products that incorporate derivatives so that the outcome (mainly income) is more defined. Investors are paying a modest fee (compared with actively managed funds) for the intellectual property of the manager.
Investors in ETFs can also manage their own cash. Actively managed unit trusts often hold non-trivial allocations to cash, for both market timing and liquidity purposes.
Unfortunately, they charge the full fee on cash held and when markets are rising there's an obvious cash performance drag.
If an investor is on the younger side with fairly limited responsibilities, ETFs can provide a low-cost, high-gain investing adventure.
There are geared funds, crypto funds, factor-style funds. Sure, there are risks but, by and large, investing is a sum positive game (unlike gambling, which is sum negative).
Controlling the cost
For the investor with responsibilities, and by that I mean people who have families or are investing for their future self - those following the FIRE (financial independence, retire early) trend or those just wanting to retire like a normal person - there are also adventures aplenty, but more controlled. Preparation is still a key for these people.
The first thing to understand is cost. ETFs might be cheaper than actively managed funds, but cost is still important.
Fundamentally, you need to know the ongoing management fees and what the trading costs are. Some ETF managers - specifically Vanguard and Betashares - have their own investment platforms where investors can invest with no brokerage and for as little as $200. Start early enough and $200 a month builds to something meaningful.
Rising popularity
How popular are these approaches?
Well, recent research that I conducted showed that Vanguard had the highest sustainability of monthly net flows of all the ETF managers. It might not be the proverbial smoking gun, but it is pointing in the right direction.
The Betashares platform hasn't been going two years yet so it's difficult to determine what impact this has had on its net flows, but I'm hopeful. Anything that makes it easier and cheaper to invest is alright by me.
Last year I did a deep dive on the cheapest products in the ETF market. What I found was that an investor could create their own balanced portfolio for as little as 0.1% a year. This gets
a basic portfolio of equities, fixed interest and cash in a 60/30/10 configuration.
If people wanted to implement some of their specific investor objectives, such as a desire for income-focused share funds or products with factor styles (value, growth, equal weighted and stuff such as that), a portfolio could be had for less than 0.4%.
Choose Your Own Adventure
That's what I mean by being able to choose your own investing adventure.
You can control the costs to suit yourself. You can control the risks (subject to the normal investment adventures that come from systemic risk) and you will come to understand the consequences of decisions.
In the end, the person who chooses their own investing adventure will be a changed person.
They will have had adventures, hopefully they will be better off financially, they will have learned from both their successes and their failures, and they will have looked after the people they hold most dear. What more can anyone ask?
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