Exchange-traded funds (ETFs) have become a cornerstone of modern investing, especially for those with long-term goals. But their rise to prominence didn’t happen overnight. Wondering why ETFs are such a big deal today? Let’s look at how people used to invest, the changes ETFs brought to the table, and why they’re the go-to choice for so many long-term investors .
Investing before ETFs: the old-school way to diversify
Before ETFs came along, getting diversified wasn’t exactly simple. If you wanted to spread your money across a range of sectors or indexes, your options were limited. One popular choice was mutual funds (also called managed funds ). These funds collected money from an array of investors to create a mix of investments. A professional fund manager made the decisions on what to buy or sell, aiming to beat the market – though they didn’t always succeed.
In the 1970s, index mutual funds shook things up. John Bogle, the founder of Vanguard, introduced the first index fund for everyday investors – the Vanguard 500 Index Fund – in 1976. It allowed people to track the S&P 500’s performance rather than try to outdo it. While groundbreaking, these funds weren’t perfect. You could only buy or sell them at the fund’s net asset value (NAV), calculated once at the end of the day. This wasn’t ideal if you needed more flexibility.
If you wanted to invest in specific sectors , things got even trickier. You’d need to buy shares in several companies within that sector, which required time, research, and money. Sector-specific mutual funds existed, but they came with higher fees and less transparency, which put off a lot of people.
The birth of ETFs
ETFs arrived with the aim of fixing many of these headaches. The first ETF, the Toronto Index Participation Fund (TIP), launched in Canada in 1990, tracking the Toronto Stock Exchange 35 Index. The real game-changer, however, came in 1993 with the launch of the SPDR S&P 500 ETF (SPY) in the US. Dubbed “Spiders,” it quickly became a hit and opened the floodgates for ETF innovation.
In Australia, the first ETFs made their debut in 2001 with the launch of SPDR S&P/ASX 50 Fund (SFY) and SPDR S&P/ASX 200 Fund (STW) . Each gave Australian investors their first opportunity to access broad market exposure via an ETF, tracking the performance of the top 50 and 200 companies listed on the Australian Securities Exchange (ASX) . The Australian ETF market has grown significantly since 2001, with a wide range of products now available that cover local, international, sector-specific, and thematic investments.
So, what made ETFs so special? They mixed the popular parts of mutual funds and individual stocks. Like mutual funds, they offered diversification, but you could trade them throughout the day like stocks. This intraday trading meant investors could react quickly to market changes.
Plus, ETFs generally boasted much lower costs than actively managed mutual funds, making them a favourite among budget-conscious investors. And they offered transparency, with daily updates on what they held – a win for anyone wanting a clear view of their investments.
How ETFs changed the game
ETFs didn’t just make investing more convenient; they completely flipped the script. Here’s why:
1. Diversification for everyone
With ETFs, anyone could build a diversified portfolio , even with a small amount of money. Before, replicating an index or spreading investments across sectors often required deep pockets. ETFs levelled the playing field, making it easy to access entire markets with a single trade.
2. Lower costs, bigger savings
ETFs are famous for their typically low fees, especially compared to actively managed mutual funds. For long-term investors, these savings can really add up. They also shifted the focus from trying to beat the market to just being part of its growth.
3. Flexibility like never before
Being able to trade ETFs throughout the day gave investors more control. Whether you’re a buy-and-hold type or someone who likes to try and time the market , this flexibility can be a big plus.
4. Fuelling innovation in investing
ETFs paved the way for creative new options. Beyond basic index funds, we now have ETFs tailored to specific themes, sectors, or asset classes. Want to invest in clean energy or artificial intelligence ? There’s an ETF for that.
Bond ETFs made fixed-income investing more accessible, and niche products like leveraged or inverse ETFs cater to more advanced strategies.
5. A new level of transparency
Unlike mutual funds, which often reveal their holdings only quarterly, ETFs disclose theirs daily. This level of openness built trust and made them a go-to for many investors.
Do mutual funds and other old-school options still matter?
Even though ETFs are dominating the spotlight, mutual funds and other traditional investment tools aren’t going anywhere. A lot of investors still prefer managed funds for strategies that require active management or access to niche markets. Australian superannuation funds often favour managed funds as a core investment option due to their established structures and regulatory frameworks.
Index mutual funds, in particular, are still popular. They’re popular among investors who want simplicity and don’t mind waiting until the end of the day to trade at the NAV. This setup can also help avoid knee-jerk reactions to market swings.
Then there are hedge funds and other alternatives, which still attract high-net-worth individuals and institutions. These options often pursue strategies or opportunities that ETFs can’t easily replicate.
The future of ETFs: full speed ahead
ETFs show no signs of slowing down. In 2024, global ETF assets surpassed $10 trillion, and new products keep hitting the market. Active ETFs , which combine active management with ETF benefits, are growing fast. ESG (environmental, social, and governance) ETFs are also picking up steam as more investors look to align their portfolios with their values.
Thematic ETFs , focusing on trends like clean energy or artificial intelligence, remain a hot topic. Advances in technology and data analytics will likely drive even more creative offerings to meet investors’ evolving needs.
Wrapping it up: ETFs as a modern investing staple
The history of ETFs shows how innovation can reshape an entire industry. By solving the pain points of traditional investing tools, ETFs have made building wealth more accessible, affordable, and transparent. They’ve changed how people think about investing, from small-time savers to big institutions.
That said, mutual funds and other classic tools still have their place. Whether you stick with these tried-and-true options or dive into ETFs, today’s investment world has something for everyone.
Looking ahead, ETFs are likely to remain an important part of the investing world. Their ability to adapt to trends and provide efficient options for diversification has made them popular with long-term investors. Whether you're new to investing or have been at it for years, ETFs could offer a practical way to build wealth while keeping up with an evolving market.
Happy investing!
