Key takeaways:

• Historical performance is one measure to compare ETFs, but remember, this looks backwards, providing no guarantees as to how the fund will perform in the future

• ETFs that charge low fees and closely track their indices are considered efficient

Successful long-term investors would know all too well that one of the most important things to stay on top of while investing is to track the performance of your investments.

This applies equally to ETFs, just as it does with individual stocks. 

When assessing the performance of an ETF, there are a few things to consider, including the product’s historical performance, management fees, and how closely the fund tracks its benchmark index. Let’s examine these matters in closer detail.

Analyse the ETF’s Historical Performance

While past performance is no indicator of future performance, it is still a useful guide when it comes to understanding how the fund has performed through different parts of the market cycle.

What’s more, funds with a longer track record have more data behind them to illustrate their performance over the long-term, whereas a newer fund might only have a year or two to count on, which could skew numbers in one direction or another.

Regardless, you should still look at the fund’s performance for a gauge on whether the returns meet your expectations. Again, these returns are in no way guaranteed, but there is also no point investing in a fund where the historical returns do not align with your investment objectives.

Comparing ETFs by performance over different timelines may provide some context if you are having trouble choosing between products. Some ETFs will also derive more of their returns from growth as opposed to income, while the opposite may apply too. Regardless, in either case should look at management fees, which we’ll cover next.

Review the ETF’s Management Cost

An important part of looking into ETFs centres on management costs associated with the product.

For a recap on ETF management fees, read our introductory guide here.

Each ETF provider will nominate the amount that they charge to effectively manage the fund on behalf of unitholders. It is an amount deducted each year by the fund provider as a cost to run it. Naturally, it goes without saying that the lower the fee, the better.

This fee represents a percentage of your investment in the ETF. For example, if a fund manager charges a management cost of 0.3% per annum, this would correspond with $15 in fees on an investment of $5,000.

Management fees are important because over time, these eat into your returns. This is not to say that ETFs that charge the highest fees won’t deliver the highest performance, because there is no definitive conclusion that can be drawn here. But it is worth keeping an eye on these costs because they somewhat limit your investment from compounding as much as it otherwise might.

Although most experts talk about management costs, there are also other fees that sometimes need to be considered when investing in an ETF. These include indirect costs, transaction costs, and the buy/sell spread, to name a few. Make sure you read the relevant Product Disclosure Statement for an ETF to understand these costs, and how they might impact your investment.

Comparing an ETF With a Benchmark Index

Today, most ETFs are designed to track an index of some sort. Even a number of the new-age thematic products that have made it to market track an index, which means it is not just popular indices like the ASX 200 or S&P 500 to worry about.

Keeping this in mind, it is wise to look at how closely the ETF tracks its benchmark index. After all, the purpose of many ETFs is to mirror or mimic said index, so if it is not keeping pace with its target, it is underperforming.

On a more nuanced level, you will want to understand whether an ETF increased by the same amount when the index increased, and whether it decreased by the same amount when the index fell.

With that said, you should provide some allowance for the management fees described above. These weigh on overall performance when compared with an index, as the fund provider is effectively managing this product on your behalf through one simple investment vehicle that would otherwise not be practical to replicate by yourself.

However, if the performance of an ETF starts to deviate too far from the index it tracks, you may want to think about whether this is due to a particular factor with the construction of the portfolio, and whether any alternative products on the market offer exposure to a similar benchmark that better serves your goals.