'I've made money through ETFs, but I feel like I'm blindly following the crowd'

Welcome to The Money Coach, a Times of Malta column where readers can ask questions about life's money issues. Send your questions about personal finances, inheritance, gifting or other personal finance topics to moneycoach@timesofmalta.com

Dear Luca,

I've been an avid investor for some years and have managed to accumulate just over €150,000 in so-called “reliable ETFs”. I feel proud because I achieved the gains expected from this kind of investment. However, despite these gains, hearing that everyone is doing what I am doing makes me question the whole concept. What if I’ve been blindly following the crowd?

I've made a €50,000 overall gain since I started investing, but I feel some unease because I just invest in the ETF blindly. I do not really know what I am investing in, and that makes me uncomfortable.

I follow the advice that ETFs 'just work', invest every month through the so-called DCA (dollar-cost-averaging), and the returns come. While many might be satisfied with this, I am not.

I want to know what I am investing in:

a. Why ETFs?

b. Why does everyone seems to push for the S&P 500?

c. Why does Vanguard seem to be preferred as an ETF provider?’

d. Why can’t I just invest in a company of my choice? True, there's no diversification there, but history says if I invested in Apple in the past 10 years, I would have far more returns than the S&P 500.

When I look at my portfolio, I realise most of it is heavily exposed to the US market and largely driven by a handful of big technology companies. I didn’t consciously choose that concentration. It simply came as part of “buying the index.”

So sometimes I wonder whether I am truly diversified or just diversified on paper.

I don’t want to gamble. But at the same time, I don’t want to be passive just because it sounds intelligent.

Is this doubt healthy? Or am I overthinking something that has been working perfectly fine?

Concerned Investor

Luca responds:

It's good to see you looking out for your money in a very strategic way. What you are experiencing is not doubt about ETFs… it is doubt about your own conviction.

There is a big difference between investing in something because you understand it and investing in something because it is the socially accepted “intelligent” thing to do. The first builds confidence, whilst the second builds dependency.

Before I continue this reply, allow me to add that I am a financial educator, not an investment advisor, and I’d fully recommend seeking the services of a licensed investment advisor before making any decisions regarding your investments.

Let me start with the elephant in the room – why are ETFs so popular and what makes them so effective?

ETFs stand for exchange traded funds and have grown in popularity these past few years because they allow the investor to incur very small fees, and in many cases (even because of the small fees they carry), when investing in them many experience higher returns than when investing in a mutual fund (in simple terms a fund which is managed by an active fund manager).

The difference in fees can be quite big –  ETF fees might be as low as 0.1% per annum, while some mutual funds charge between 1% and 2.5% annually, plus possible entry fees.

In the past, ETF investing was not common, and did not really exist as people flocked to active fund managers. Yet, with advances in technology, ETFs became very popular, especially as more platforms began offering them.

I think the top reason there is so much emphasis on the S&P 500 is its historical data of average returns. Although it is a common saying in investing – the past is no guarantee for the future – the S&P 500 index has, for the past 100 years, made an average return of 8-10% per year. Of course, there were some years where it went down by double-digit points, and years where it did very high percentage returns. Apart from that, the past 10 years were quite good for this index as well, giving returns of around 12% per year. The S&P 500 represents the top 500 companies in the US, the world's most dynamic market.

And yet, although it is often represented as a well-diversified asset class to invest in, one must keep in mind that, at present, the top 10 companies alone make up roughly 30%-40% of the entire index, and a significant portion is heavily concentrated in technology stocks. This means that while you technically hold 500 companies, a large part of your performance may still depend on a relatively small number of dominant players.

To your point on Vanguard - it is one of the largest and most well-known providers of ETFs globally, and it built much of its reputation on offering low-cost index funds. Lower fees over long periods can make a meaningful difference to overall returns, which is one of the main reasons Vanguard became so popular.

That said, Vanguard is not the only player. Other large institutions, such as BlackRock (whose ETFs are typically branded under the name iShares), also offer a wide range of index funds with competitive pricing.

The key is not the brand itself, but understanding what the specific fund holds, what it costs, and how it fits within your overall strategy. Before choosing any fund, always review its factsheet carefully and understand the fee structure and exposure you are taking on.

And if you’re too busy to read through it, it could be a good idea to upload it to an AI platform, such as ChatGPT, and prompt it to provide you with a brief summary. It won’t replace proper advice, but it can help you better understand what you’re investing in. It’s a method I’ve used myself, and I’ve found it very helpful.

Finally, to your question on investing in individual stocks rather than ETFs. You are right in saying that if you invested in Apple in the past few years, you would have made a bigger return than simply putting them in a normal, well-diversified ETF. But while the return might have been better, that does not remove the risk you’d be taking on by putting your hard-earned money into just a select few companies.

Remember that even the biggest companies in the world may suffer a bad fate. Enron was one of the world's biggest companies in the early 2000s – just look at what happened to it. Now imagine what would happen to your portfolio if Apple lost 50% of its value in just a few weeks. ‘Impossible,’ you might scream, it’s Apple! You’d be surprised at what can happen to such companies when the tide turns against them.

The goal is not to be different from the crowd. The goal is to know why you are standing where you are standing. If you understand what you own and why you own it, then it no longer matters whether everyone else is doing the same.

Luca is the founder of the Money Coaching Hub. Email him your financial questions or your response to today's question for a chance to be featured in a future column.

Disclaimer: This column is intended to provide general information on various topics related to personal finance. The information provided is for educational purposes only and should not be construed as personalised financial advice for your specific situation. Financial decisions are highly individual and can vary greatly based on your unique circumstances, goals, and risk tolerance. The author of this column is not authorised to provide financial advice. Before making any financial decisions, it is recommended to seek professional financial advice from an authorised financial advisor.