This page has an average rating of %r out of 5 stars based on a total of %t ratings
Reading Time 9 Minutes Reading Time 9 Minutes
Created on 03.04.2024

Long-term asset generation with ETF saving plans

To achieve major financial goals, it is best to make long-term investment plans. ETF saving plans are an easy way of making diversified investment in various markets, while also providing the opportunity to build up assets long-term. They are more flexible and often less expensive than actively managed funds saving plans.

What is an ETF?

To explain how ETF saving plans work, firstly let us take a look at ETFs in general. Exchange traded funds (ETFs) are investment funds that track the performance of an underlying index as closely as possible – for example, the Swiss Market Index (SMI) or S&P/Dow Jones. If the SMI rises, so too does the ETF. They are also traded on the stock exchange – a major difference to traditional funds. This enables investors to buy and sell units during trading times, usually providing a high degree of liquidity and flexibility. ETFs do not generally aim to outperform the market either – unlike traditional funds.

The key features of ETFs at a glance

  • ETFs generally track indexes, which serve as a market barometer, and reflect the performance of an entire market. That is why they are generally well diversified, allowing investors to distribute risk.

  • ETF costs are often lower than actively managed funds. That’s because, unlike the latter, no issue premiums are charged and management fees are lower so that fund managers incur few costs.

  • Even in volatile markets, large ETFs generally have a high level of liquidity as they are traded like equities during stock exchange trading times. That enables investors to trade quickly and at current market prices. ETFs’ flexibility also extends to various trading options that give investors control over their transactions, including market, limit and stop orders.

Exchange traded funds (ETFs) have many benefits, but there are some drawbacks too. Although ETFs usually have lower management costs than actively managed funds, returns can be eroded if frequent trading takes place, as trading fees are incurred on ETFs. ETFs are also exposed to price fluctuations, just like other stock market investments. However, the fluctuations are generally less extreme that for individual securities, for example, as their underlying indexes track broad market segments and sectors. There is a risk of over-concentration if particular sectors or companies are overrepresented in the ETF. There is no choice over the companies contained in the fund.

What is an ETF saving plan and how does it work?

An ETF saving plan is based on a similar principle to a conventional savings plan where a set amount is paid monthly (or at other regular intervals) into a savings account or a funds saving plan, where the money is invested in a fund. Investors who opt for an ETF saving plan continuously invest a certain amount in one or more ETFs of their choice. It is an ideal option for long-term asset generation. Here is an overview of the key features and conditions of this investment solution:

ETF saving plans are also suitable for small budgets

An ETF saving plan is worthwhile even if paying in small amounts, and is very flexible. Flexibility here means the entire amount is always available and is not tied to conditions – as is the case with the 3a account, for example. This allows you to continually make changes to the saving plan. You can withdraw money from the ETF saving plan if you need to, or make additional inpayments. Use the The link will open in a new window ETF saving plan calculator on ishares.com to find out whether an ETF saving plan would be a worthwhile investment for you.

A long-term approach is key

The longer an ETF saving plan’s investment horizon, the greater the return generated. At least ten years is the guideline period. Two key effect mechanisms play a part in ETF saving plans.

Firstly, ETFs benefit from the compound interest effect. This kicks in when return from ETF investments are in turn reinvested. This means the total assets see exponential growth over the time horizon as the return builds on gains already made.

The other key factor is the cost-average effect. The cost-average effect is based on regular, fixed investments, regardless of market conditions. This means investors buy more units when prices are low and less when prices are high. This results in a more favourable average price long-term.

Regular payments make all the difference

Regular payments are vitally important, especially to achieve long-term goals and consistent growth. Various options are available: investors can make annual payments or use a monthly plan. More frequent inpayments enable investors to achieve a closer link with the cost-average effect. A saving plan with (automated) monthly payments is often the preferred option to help even out market volatility.

Return on an ETF saving plan and what it depends upon

Various factors influence the return generated by an ETF saving plan. As ETFs generally track the performance of an index, yields mainly depend on how well the underlying index performs. For example: if you invest in an ETF that tracks the Swiss Market Index (SMI), then this follows the SMI’s performance. Historically, well diversified ETFs have usually achieved solid returns long-term, but the average annual return varies depending on market conditions. However, investors need to understand that ETF saving plans can sometimes also result in losses. That happens if the value of the assets contained in the ETF fall over the investment period.

What do you need for an ETF saving plan?

Anyone can set up an ETF saving plan. There are a few key points to note though.

To set up an ETF saving plan, you need to open a custody account with a bank, like PostFinance, that provides ETF saving plans. But first of all you need to think about your strategy. That means deciding how much money you would like to invest and over what period of time. That depends on your personal needs and many ETF saving plans can be set up with contributions of just CHF 20 a month.

Once you have done all that and opened a custody account with a bank, you then need to consider which ETF you wish to pay into. Now you have to decide on the payment interval. ETF saving plans are very flexible – you can make changes to inpayments regularly or stop them if need be.

A summary of the individual steps

1. Financial planning

  • Set the saving amount (e.g. CHF 100 per month)
  • Define the investment horizon (e.g. 15 years)

2. Selection

  • Open a custody account with a bank
  • Select the ETF

3. Implementation and management

  • Decide on the payment interval and execution date
  • Manage the saving plan: payments can be stopped or changed at any time

Selecting the most suitable ETF – a few key pointers

Selecting the right ETF requires careful research and exact alignment with individual needs. In principle, an ETF can track any index, such as the SMI, SPI DAX, etc. Some indexes are created especially for a particular purpose (e. g. real estate, blockchain technology etc.). There is a wide choice: around 1,600 different ETFs are traded on the SIX Swiss Exchange.

It is important to consider a few things beforehand to ensure you make the right choice:

  • Before getting started on selection of an ETF, it is important to define clear investment goals. Think about the asset classes you would like to invest in, such as equities, bonds or commodities. To narrow the investment focus, additional criteria can be defined. In the equities asset class, one single ETF allows you to invest in the global equity market, a region or a specific country. You can also focus on sustainable companies, a particular sector or specific investment themes.

  • Consider how much risk you are willing to assume. Your risk appetite influences the selection of ETF and your asset allocation. The greater the risk appetite, the higher the return that can be generated in theory. However, the same is true of losses too.

  • ETFs usually only incur low costs, but they may vary within the ETF marketplace. Depending on the custody account provider and ETF issuer, trading and custody costs can be kept very low. When working out costs, it is important to look at the  total expense ratio (TER). Low costs are a key factor in long-term return.

  • Check the ETF’s trading volume to ensure it has sufficient liquidity. ETFs with higher trading volumes are traded in a narrower range, resulting in smaller differences between purchase and selling prices.

  • Look at the ETF’s historic performance. However, it is important to be aware that past performance is no guarantee of future returns. Check the tracking difference to find out how precisely the ETF tracks the index.

  • If you prefer regular returns, look at the ETF’s dividend yield to see whether it is generating income.

ETF saving plan vs funds saving plan: the main differences

Both the ETF saving plan and traditional funds saving plan fall into the category of long-term investment. However, there are a few key differences.

Investment strategy and performance

In the case of a traditional funds saving plan, inpayments are usually made into actively managed investment funds. Actively managed means fund managers try to outperform the market by selecting specific securities and making portfolio decisions. In contrast, ETFs are usually passively managed and do not seek to outdo the market. As explained above, they track an index as closely as possible. That also has an effect on performance. While ETFs generate the returns of the underlying index, actively managed funds aim to exceed market yields. How successful that is depends on the fund managers.

Costs

The active management of traditional funds means ETF saving plans are often much less expensive than active funds saving plans. Fund management alone accounts for a big share of the costs involved. It includes administrative costs, custody fees and sometimes a performance fee if the fund manager exceeds a certain level of return. Then there are additional commissions for the purchase and sale of fund units. That means a fund’s TER can soon reach 0.5 to 2 percent of the assets invested.

In the case of ETF saving plans, there is generally no active fund management, and the transaction fees are lower too. That usually makes it the least expensive option. For example, the TER of equity-based ETFs is between 0.04 to 0.95 percent per year on average.

Transparency

ETFs are transparently structured. The portfolio composition is the same as the underlying index, but may differ slightly. This deviation from the underlying index is called the tracking error – the higher this value, the greater the deviation from the index. This gives investors a great deal of control over the securities they invest in. As ETFs are traded on the stock exchange, you can also check exactly how they are performing at any time of the day.

Traditional funds saving plans are less transparent by comparison. The portfolio composition is published regularly as a report.

Risk

ETFs and actively managed funds are exposed to the same capital market risks and the performance of both investment types is unpredictable as prices can fluctuate. There are a few differences in terms of risk as they work in different ways. For example, the issue costs of funds saving plans can vary significantly. If the fund focuses on a particular region, currency or sector, the risk is greater. However, the fund managers can control the risk and adjust the portfolio according to the situation, which is not the case with ETFs.

This page has an average rating of %r out of 5 stars based on a total of %t ratings
You can rate this page from one to five stars. Five stars is the best rating.
Thank you for your rating
Rate this article

This might interest you too