The ETF jungle
Not all funds and ETFs are suitable for small investors and the proliferation of active ETFs (with leveraged, crypto-currencies or actively managed ETFs) does not make the selection easy. You will therefore need to adopt a methodical approach to select a handful of passive ETFs corresponding to market indices.
To start, you will need to select passive ETFs (e.g. 1-4) from reputable providers (such as Vanguard and iShares) to achieve the broadest possible diversification. You should base this selection on known benchmarks. For guidance, here is a list of the main indices you can consider when defining your menu of ETFs:
The MSCI World Index tracks approximately 1’600 companies in 23 industrialized countries. The MSCI indices (MSCI World and MSCI country indices) have the advantage of being composed according to the same criteria in all countries, which makes them easily comparable.
The Dow Jones Industrial Average (often referred to as the Dow) is regularly cited in the media, but it does not really reflect the US market well. Companies such as Amazon, Alphabet (Google’s parent company) and Tesla are not among the 30 stocks in the index, even though they are now among the top ten US companies in terms of market capitalization. The reason is that an editorial board of the Wall Street Journal determines the composition of the Dow without using the mechanical size criteria usually used:
S&P 500: The Standard & Poor’s 500 Index provides a better overall picture of the U.S. stock market, even though it contains no small-cap companies. Referring to the Vanguard S&P500 ETF (VOO), we see that it has over 500 stocks and stock classes. Some companies, such as Alphabet (Google), actually have multiple share classes, and the index includes them all.
The Nasdaq Composite includes more than 3,000 companies from the Nasdaq market, mainly from the technology sector.
In Europe, there is the Euro Stoxx 50, which includes the 50 largest companies, and the Euro Stoxx 600, which includes the 600 largest listed European companies.
Each country then has a main index, generally based on the securities quoted on the country’s main stock exchange: the DAX for Germany, the CAC 40 (40 largest capitalisations) for France, the SMI (30 main stocks) and SPI (companies quoted on the Swiss stock exchange with a ceiling for the three largest companies Nestlé, Novartis and Roche) for Switzerland. In addition, there are often numerous secondary indices, such as indices reflecting different capitalization categories (e.g. small- or mid-caps).
Emerging markets indices
The MSCI Emerging Markets Index covers approximately 1,400 public companies in 27 emerging markets.
The FTSE Emerging Markets Index also covers emerging markets, but with a higher weighting to Chinese A-shares and China-related companies.
Two indices that appear similar at first glance may have very different methodologies and criteria. Caution is therefore required in the selection process.
From indices to ETF investments
In order to invest in an index, you will need to go through diversified index funds (usually in the form of ETFs for investors domiciled outside the US). An index fund is a fund that represents all the stocks in the index. Instead of buying stocks, you buy units of the index and, in doing so, you buy the equivalent of all the stocks in the index. Your performance will be virtually identical to the market. If the market does well, your shares will do well. If the market goes down, you’ll go with it.
Remember, good index funds (and not all are good) meet the criteria of passive management that allows for market or index performance, low fees, diversification and transparency.