Before I start my reply, I want to congratulate you for being in the envious position at a young age to be debt free and have R30 000 available monthly for onward investing. Well done!
In your question, you also refer to having retirement policies which will pay R7.5 million at retirement.
I would like to make two comments on this statement:
- Retirement ‘policies’ do not provide guaranteed returns. I assume that these retirement policies that you refer to are life-underwritten retirement annuities that provide assumptions and projections of future returns. They normally indicate a ‘high scenario’ as well as a ‘low scenario’ assuming different future returns. Be very careful of accepting these projected values as guaranteed values. Historically these forecasts have in most cases overestimated future values. I suggest you revisit the investments and investigate how and where the funds are invested and, based on those fundamentals, do your own calculations of projected future values. If you have difficulty with the calculation ask a financial planner to assist you.
- Assuming you are planning to retire at the age of 65 then the current value of the projected R7.5 million will be approximately R2.2 million today if inflation of 6% per year is taken into consideration. Use this amount to do your planning and not the R7.5 million.
Now to your actual question. exchange-traded funds (ETFs) or shares?
As many of my readers have come to know, my answer is going to start with, well, it depends …
My first comment is that ETFs are shares (if you choose an equity ETF).
For you to make an informed decision I would like to point out a few facts.
|Capital gains tax (CGT)||On every trade. Every time a share is sold, CGT will be triggered.||Once the ETF is sold. Rebalancing the ETF does not trigger CGT.|
|Portfolio||Discretionary depending on investment style. This will either be your choice or that of a broker/discretionary manager.||Own the index. Comprise the largest companies in the particular sector.|
|Flexibility||You can have influence on the underlying share choices.||ETFs are rigid and will not deviate from the portfolio.|
|Choice||The whole global stock market or a managed discretionary solution.||ETFs vary by sector, country and mandate. Many choices exist.|
|Ownership||You will own the underlying shares.||You will own the ETF and not the underlying shares.|
|Cost||Trading costs, brokerage costs, management fees and so on, and, if discretionary, admin/management costs.||ETFs are considered the same as shares. The same costs will apply except with much lower admin/management fees.|
|Motivator||You believe in active management and selection.||You believe in low costs and owning the market. No manager or individual intervention.|
I find it interesting that you only mention shares or ETFs and not unit trusts. Is there a particular reason for that? If you are an astute investor and you have the skill to select your own shares, then I understand.
Many investors choose ETFs (also referred to as passive funds and trackers) because of the low costs associated with them.
The perception that you do not need to make a choice when investing via ETFs is a bit misleading.
There are approximately 50 direct ETF funds available on the SA market and probably as many ETF structured unit trusts. That leaves you with a choice of more than 100 product choices which may differ in risk and composition. Add offshore options in the passive space, and the choice multiplies handsomely.
Investors mainly fall into two camps …
The ones that are fee-sensitive and are happy owning the market at a low cost, and those that don’t mind paying a higher fee for active management and the possibility to outperform the market. These investors will typically rather invest in a discretionary share portfolio or unit trusts.
I am not going to try and convince you which one is better. All I can say is that the underlying shares within passive funds/ETFs are often the largest companies in an index by market capitalisation and they also tend to be the more expensive shares.
The basic principle of investing is to buy shares or any asset for that matter at a reasonable price.
Over the last few years, passive funds outperformed actively managed funds – but the last few years, since the Great Financial Crisis (GFC) in 2007, were not normal years in the investment environment.
Prior to the GFC actively managed funds outperformed passive funds in the same way that value-style funds outperformed growth-style funds.
Since the GFC and through Covid, the roles reversed with growth style investing and passive funds faring better than value style and actively managed funds. Last year, the old trend emerged with passive funds trailing the active managed equity sector average return by some margin … Maybe we are back to the old trend where the price you pay really does matter. I for one surely hope so …
I also want to point out that investments should consist of more than just equity investing. Asset allocation is of crucial importance, especially during turbulent times.
Asset allocation and regional or global selection should be the backbone of any investment strategy.
This is the one space where passive funds or ETFs falter. Where multi-strategy global ETFs/passives rely on static asset allocation, funds often have too high exposure to asset classes that should be avoided given certain circumstances. Global bonds are a perfect example of this. The adage of having 60% in equities and 40% in bonds in a typical global multi-asset ETF style ‘balanced fund’ or 40% equities and 60% bonds in ‘stable fund style’ crashed and burned spectacularly last year when global bonds blew out due to the aggressive raising of interest rates in developed markets. Active funds where managers substituted bonds with cash fared much better than their passive counterparts.
All the best with your investment decision. You are welcome to send me any questions. I will gladly assist.