Low-Cost Investing with Index Funds and ETFs

Low-Cost Investing with Index Funds and ETFs

Fees can cut into the returns on an investment. In the case of funds, passive products such as ETFs and index funds are an interesting alternative to traditional investment funds for low-cost investing. They particularly perform well in a long-term comparison.

Have you ever been excited about a return—until you saw what was left after the fees? It always costs money to buy and sell securities. It is especially important to compare fees for investments that don't just carry a transaction fee when you buy them, but also charge management fees later on. Funds are one example of this.

Investment funds are an ideal way of investing smaller amounts and ensuring a good investment mix. However, you should pay attention not only to the returns, but also to the fees. Funds that are actively managed by a fund manager pass their personnel expenses and trading fees on to investors. Passively-managed index funds and ETFs, in contrast, often offer better value to individual investors.

Why Passive Is Often Better than Active

Higher costs are worthwhile if the returns are higher because market opportunities are actively utilized. However, in a long-term comparison, actively managed funds are not necessarily better than passive ones, because many fund managers track the index (an index measures the change in performance of a security over time) too closely. So it may be worth checking whether the fund is, in fact, actively managed.

Otherwise, passive products are often a good alternative for investors because, ultimately, more is left over after the fees and costs have been deducted. These investments use an index as the underlying asset. This may be an index for equities, raw materials, or interest rate products. They replicate them 1:1, either physically or indirectly. Thanks to low research costs and a high degree of automation, the management fees can be kept to a minimum.

Investing according to an Index Is Restrictive

At the same time, investors must be aware that index-based investing will restrict their options. It is not possible to favor or exclude specific companies. For instance, no corrections can be made if a security or sector is overvalued. Moreover, stock indices often cover only part of the market, because the leading indices of a country (such as SMI or Dax) include only blue chip stocks.

Index funds and ETFs are not immune to risks, either. If the market drops, so do the indices. Actively managed funds can try to reverse this trend, but passive funds cannot. And as these funds track the index, they are also unable to generate a higher yield than the market.

ETF or Index Fund?

In spite of the restrictions, however, it may make sense to invest part of your portfolio in an index fund. It is an easy way to invest in the economic development of a country. Various investment types allow for this.

The most popular option among private investors is Exchange Traded Funds, or ETFs. These are traded on the stock market, which means they offer transparency and liquidity. ETFs replicate the index either physically or indirectly with derivatives. Unlisted index funds, which are offered by financial institutions, work in almost the same way.

Index Funds Open to Private Investors

Credit Suisse index funds always replicate the index physically, so equities or bonds are actually purchased. They are often also cheaper than ETFs, because a listing on the stock exchange costs money. They also adjust to the index only once a day, not continually.

For a long time, only institutional investors could invest in index funds while private investors were excluded. However, small-scale investors can now purchase index fund units, too. Credit Suisse recently opened up 48 index funds for private investors.

Tracker Certificates as a Third Option

The third option for passive investments using an index solution is tracker certificates. They also replicate the underlying index 1:1, albeit indirectly. In terms of costs, they are often the cheapest alternative, because there are usually no management fees. The purchase of products is sometimes also cheaper than with passive funds.

However, there are differences in the returns. Unlike ETFs and index funds, stock dividends are not always passed on to the investors. This may mean lower income. The risk is also somewhat higher for certificates, because if the product’s issuer goes bankrupt, all of the investment may be lost.

Index funds, ETFs and tracker certificates are interesting alternatives for investors who what to invest passively. Each investor must make up their own mind about the advantages and disadvantages of these three options and choose which is best for them.