In this era, there are many ETFs (exchange-traded funds) covering different asset class, investing styles, themes, sectors, and geographies. Adding to the complexities are tax implications for investing in ETFs of different domiciles. With so much choice, how do you as an investor pick the right one?

In summary, here are the few criteria you might want to use to pick the right ETF:

  • Asset class
  • Broad market or sector-specific
  • Active or passive
  • Domicile (tax implications)

Just to add that these criteria could apply to mutual funds as well. The main difference between mutual funds and ETFs is accessibility. You can invest in ETFs easily through any broker that provides access to the exchange the ETF is listed on. In contrast, mutual funds are distributed through financial institutions.

Asset class

First and foremost, you need to decide what underlying asset class you’d like to invest in. The most common mainstream ones are equities and bonds but others are increasingly gaining traction, e.g. real estate, commodities, derivatives, and even cryptocurrencies (though limited ETF options for now).

If you intend to invest in several asset classes, consider creating an asset allocation plan first.

Over long period go time, equities a.k.a. stocks have historically been the best performing asset class.

Broad market or sector-specific

Next, you need to decide whether you want broad exposure to the market, i.e. into all sectors, countries, etc. or a smaller segment of the economy. There are many ways to slice the pie, the most common being by sector/industry.

For instance, if you want to gain exposure to equities in all sectors in the U.S., you can buy an S&P 500 ETF like the Vanguard 500 Index Fund ETF (VOO). If you want global equities exposure, you can consider the Vanguard Total World Stock Index Fund ETF (VT) which tracks the FTSE Global All Cap Index. If you want sector-specific equities exposure, you can get it through sector ETFs like those offered by SPDR.

Active or passive

Do you want to try to beat the market or are you happy to settle with market average returns?

Passive ETFs usually track an index or benchmark, and are also known as index ETFs. These indexes are typically created by index providers like S&P, FTSE or MSCI. The fund manager’s job is then to track the index as closely as possible and to do it as affordably as possible. Some popular index ETF managers include Vanguard, Blackrock, and State Street.

Active ETFs in contrast, allow the fund manager more discretion in deciding which securities to trade. Typically, active fund managers do still have a mandate known to investors but they don’t have to stick to it strictly, unlike what passive fund managers have to do with indexes. More discretion brings with it potential for outperformance but also underperformance, and is much more dependant on the fund manager’s capability. ARK Invest ETFs are an example of active ETFs that have gained prominence in recent times.

Domicile

Last but not least, which country the ETF is domiciled has important tax implications that investors shouldn’t ignore. Tax is a complex issue and depends on many variables, e.g. tax residency of the investor, tax treaties between countries involved, etc. I’m not a tax expert so I can’t go into much detail. What I can say is that if you can invest in ETFs with favourable tax treatment, you can save considerable amounts in taxes which otherwise would eat into your returns.

For instance, non-U.S. residents investing in U.S.-domiciled ETFs will have to pay withholding taxes on dividends and possibly estate taxes in the event of death.

For Singapore-based investors, we are subject to 30% withholding tax and estate taxes of 18-40% on assets worth >US$60k. One popular way to reduce these taxes is to invest in Irish-domiciled ETFs instead, which are only subject to 15% withholding tax and no estate taxes.

Read also this post from Seedly: Definitive U.S. Stock Investing Taxes and Fees Guide for Singaporean Investors

Closing thoughts

ETFs (especially index ETFs) are generally considered a simple, diversified, and low-cost way to start investing for beginner investors. However, there are still many factors you need to consider in choosing the right ETF for your investment objective. Hope this short post helps you in your process to find the right one.

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Disclaimer: This is not financial advice. I am not professional financial advisor nor do I work in the finance industry. Anything I write here is purely my personal opinion. Please do your own research and due diligence before investing into anything. All investments come with associated risks. Best to consult a financial advisor if you’re still unsure.

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