The only two types of ETFs that are actually worth buying


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There was a time - not all that long ago - when an investor had three options: pick your own stocks, send a cheque to a fund manager or buy shares in a listed investment company - basically an ASX-listed fund, of sorts, whose investment success (or failure) was roughly reflected in changes in the share price.

Those were the days before listed funds known as exchange traded funds (ETFs). The first ETFs mirrored market indices: think the ASX 300 or S&P 500. But they don't need to be.

As long as you meet the ASX's listing rules, these days it's easy to start a managed fund and have it listed on the stockmarket, so that people can buy and sell it the same way they buy and sell shares. And, in the US at least, there are reportedly more ETFs than there are companies on the market.

two types of etfs worth buying

If that sounds strange to you, it should. And if it sounds counterproductive, you're on the right track, too.

At their best, ETFs give investors low-cost access to whole indices, sectors or investment strategies. At their worst, they're expensive structures designed to find new ways to separate investors from slivers of their cash. After all, those yachts and holiday houses won't buy themselves.

Yes, that's a little cynical ... but only a little.

Over time, it's reasonable to assume (and, in my case, hope) the number of ETFs falls.

Many are simply copies of other ETFs, provided by different managers. And the more funds there are, the higher the fees (because each has less scale benefit than if there were fewer, larger funds). And others are based on investment strategies that simply won't stand the test of time.

That's the future, though. The challenge, in the present, is to work out which ETFs are worth buying.

For my money, it's only worth investing in an ETF for one of two reasons: you want cheap, broad diversification or you want an investment strategy you can't invest in directly.

After all, if you're going to do the work to make sure an investment strategy is sound - and you think you're good at that sort of thing - you might as well buy the underlying companies themselves and avoid the extra layer of fees. For example, buying an "Australian banks" ETF - and paying a fee for the privilege - would be a little silly, when you could own the banks directly.

In the "broad market" category, you might want to invest in the ASX 300, the S&P 500, the NASDAQ 100 or the "whole world" MSCI global index. For what's usually a tiny fee, you'll get the returns of the market as a whole - a very simple, cost-effective, one-stop shop.

In the "investment strategy" bucket, you might want to invest in, for example, Asian technology companies, global cybersecurity businesses or a selection of international oil companies, all without multiple international trading accounts.

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Scott Phillips is chief investment officer at The Motley Fool. You can reach him at @TMFScottP on Twitter and via email.