Five things Aussies should check before investing in an ETF

Australians love ETFs, and with good reason. They're low cost, easy to trade and make diversification simple. But with more than 400 now listed on the ASX, not every ETF deserves a spot in your portfolio.

So how do you figure out which ones are worth a closer look? At InvestSMART, we look at five key metrics when we choose ETFs for our diversified portfolios: size, fees, liquidity, tracking error and bid/ask spread. These also form the basis of our five-star ratings and are simple checks any investor can use when comparing similar funds.

Here's a closer look at each of them and why they're important.

Size: bigger is usually better

Size, or funds under management (FUM), is one of the clearest indicators of an ETF's strength. Larger ETFs benefit from economies of scale, which makes them cheaper to run and less likely to be shut down. Smaller ETFs, even those with good returns, are at greater risk of being wound up because they often don't reach the scale needed to remain viable.

Closures happen more often than many investors realise. And when that happens, you don't get to choose the timing - you're forced to sell, which can mean locking in a loss or triggering a capital gain you weren't planning for.

That's why size brings stability. Large, broad ETFs such as the Vanguard Australian Shares ETF (VAS), which holds more than $20 billion in assets, are the types of funds that tend to stick around.

Fees: small differences, big impact

ETFs are known for being low cost, but fees still matter. The management fee (MER) directly reduces your return, and even small differences add up over time.

For example, based on InvestSMART's data, fees for Australian share ETFs range from 0.04% to 0.40%, with the average sitting at 0.18%. Over the 30 years to June 2025 Australian shares returned an average of about 9.3% a year, according to Vanguard. If you invested $50,000 and earned that return, at a low fee of 0.04% your balance would grow to roughly $712,000 over 30 years. At the average fee of 0.18% it would be closer to $683,000, a difference of around $29,000 from a fee gap of just 0.14%. Comparing fees between ETFs that track the same index is crucial. The lower the fee, the closer your returns will be to the index, and the more of your money stays invested and compounding for you.

Liquidity: can you get in and out easily?

Liquidity is important but often misunderstood. Put simply, it about how easily you can buy or sell an ETF at a fair price. A highly liquid ETF lets you trade quickly without the price jumping around. An illiquid one can be slower, harder and more expensive to buy or sell.

A helpful analogy is buying apples. Buying apples at a major supermarket is easy: there's plenty of stock, lots of customers, and prices are stable. That's high liquidity. But at a small roadside stall, there may be only a few apples, some days there are none, and prices move depending on who turns up. That's low liquidity.

Investing in a liquid ETF is like shopping at the supermarket. You get a fair price, you can buy or sell whenever you need to, and the price won't suddenly jump. Trading is smooth and predictable.

With ETFs, liquidity doesn't just come from how often the ETF itself trades. It also depends on how easily the companies inside the ETF can be traded. An ETF filled with large companies like BHP or Commonwealth Bank is naturally very liquid. One full of small, niche companies is less liquid.

That's why broad-based ETFs tracking major indices, such as the ASX 200, tend to be highly liquid, and why they're often the preferred building blocks for diversified portfolios.

Tracking error: does it actually follow the index?

Index ETFs are designed to follow the index they track, and the tracking error shows how well they manage to do that. A tracking error of less than 0.5% a year is considered acceptable for broad market ETFs.

Why does it matter? If the index goes up 10%, you want your ETF to deliver something very close to 10%, minus its fees. A low tracking error means you're getting the performance you signed up for. A high one can be a sign the ETF isn't replicating the index well.

Bid/ask spread: the hidden cost

The bid/ask spread is the gap between what buyers are willing to pay and sellers are willing to accept. The difference is essentially a hidden cost because it affects the price you end up paying when you buy and the amount you receive when you sell.

Large ETFs usually have spreads of a few cents while niche funds can have much wider spreads. Checking the spread before you invest can help you avoid paying a premium when you buy or losing more than you need to when you sell.

We use these factors in our annual ETF Scorecard, which rates every ETF on the ASX, and it shows one thing very clearly: choosing an ETF isn't about chasing trends. It's about understanding structure, size, cost, liquidity and how well the fund does its job. Keeping these basics in mind makes it much easier to sort through your options and build a low-cost portfolio that can go the distance.

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