Investing today has the potential to be incredibly straightforward – you can diversify your portfolio in just a few clicks. But before ETFs existed, diversification wasn’t as simple. Investors had to rely on different strategies to spread their risk, often requiring more effort, research, and capital. So how did they do it?

Exchange-traded funds (ETFs) have become a go-to tool for diversification, allowing investors to spread risk across various asset classes, industries, and geographies with a single trade. The relative convenience, low cost, and accessibility of ETFs have made them a staple in modern long-term portfolios.

However, ETFs are a relatively recent financial innovation, having only been introduced in the 1990s. Before their emergence, investors had to find alternative ways to spread risk and build wealth.

This raises an important question: How did long-term investors achieve diversification before ETFs, and how has the investing landscape evolved as a result?

What are ETFs?

ETFs are investment funds that trade on stock exchanges, much like individual shares. They hold a collection of assets, such as stocks, bonds , commodities , or a mix of these. This allows investors to gain exposure to broad market segments without having to buy each underlying asset separately.

This pooled structure makes ETFs a potentially efficient way to spread risk, as a single ETF can provide exposure to hundreds or even thousands of different securities. (NB: You can learn more in our guide to how ETFs work .)

ETFs have revolutionised long-term investing around the world, but they weren’t always available. Before their invention, investors relied on a range of other diversification strategies.

How investors diversified before ETFs

Before ETFs came onto the scene in the 1990s, long-term investors relied on several strategies to achieve diversification. These methods evolved over time as financial markets developed and access to different investment products expanded.

Direct stock selection (pre-20th century and beyond)

Long before ETFs, investors looking to diversify had to do it the old-fashioned way: buying shares in multiple individual companies across different industries. For example, an investor in the early 20th century might have purchased shares in banks like Commonwealth Bank, mining giants like BHP, and agricultural companies to spread their risk.

However, this approach had significant downsides. First, purchasing and managing multiple stocks required substantial capital, limiting access for everyday investors. Second, acquiring a well-diversified portfolio demanded deep financial knowledge and significant effort in researching companies. Plus, transaction costs were high, and brokerage fees could eat into returns.

Investment trusts (late 19th century onward)

The late 19th century saw the introduction of investment trusts, which were among the earliest pooled investment vehicles. These trusts, structured similarly to modern-day listed investment companies (LICs) , allowed investors to pool their money to invest in a diversified portfolio managed by professionals. One of the earliest Australian examples is Argo Investments, established in 1946, which remains a popular LIC today.

Investment trusts provided diversification benefits but were relatively illiquid compared to modern ETFs. Because they were traded like stocks but with a limited number of shares, their prices could deviate from the actual value of their holdings (net asset value), potentially creating inefficiencies.

Managed funds (1920s onward)

Managed funds (also known as mutual funds) became a mainstream option for investors in the mid-20th century. These funds allowed investors to pool their money and have professional fund managers select a diversified portfolio of assets on their behalf.

Despite their potential benefits, managed funds had some downsides. Many charged high management fees, and some came with entry and exit fees, which ate into returns. Additionally, units in managed funds were priced only once per day, meaning investors couldn't trade them throughout the day like stocks.

Index funds (1970s onward)

A major shift in diversification came with the introduction of index funds . Vanguard’s launch of the first index fund in 1976 allowed investors to passively track market indices, such as the S&P 500 , rather than rely on active management. In Australia, index funds became popular in the 1990s, offering low-cost access to diversified portfolios tracking indices like the ASX 200.

However, index funds were still structured as managed funds, meaning they lacked intra-day trading flexibility. This limitation set the stage for the development of ETFs, which combined the advantages of index funds with the trading convenience of stocks.

How ETFs changed the diversification landscape

The advent of ETFs in the 1990s and their introduction to Australia in 2001 revolutionised how investors approached diversification. These funds provided:

• Lower costs: ETFs generally have lower management fees compared to actively managed funds.
• Liquidity: Unlike managed funds, ETFs trade on the ASX throughout the trading day, allowing investors to enter and exit positions instantly.
• Greater accessibility: ETFs enable everyday investors to access a wide range of markets, from Australian equities to global tech stocks and emerging markets .
• Tax efficiency: ETFs tend to be more tax-effective than managed funds due to their unique structure, which minimises capital gains distributions.

With these benefits, ETFs have become a preferred vehicle for many Australian investors seeking diversification.

You can find out more about the history of ETFs here!

Do people still use pre-ETF methods of diversification?

Yes – many investors still use older methods to diversify their portfolios . Investing strategies are deeply personal, and different approaches suit different needs.

• Managed funds: These investing vehicles remain widely used, particularly in superannuation accounts and by investors who prefer active management.
• Direct stock selection: Some investors still prefer picking individual stocks , whether for control, tax efficiency, or personal conviction.
• LICs and investment trusts: LICs, similar to traditional investment trusts, continue to provide diversification options, especially for income-focused investors.
• Index funds: Though ETFs have gained popularity, traditional index managed funds are still favoured by investors who prioritise long-term, buy-and-hold strategies in retirement accounts.

Each of these strategies has its pros and cons, and the best approach depends on an investor’s individual goals, risk tolerance , and investment horizon.

Finding the right diversification strategy for you

At the end of the day, how you diversify depends on your financial goals, risk tolerance, and investment preferences. ETFs have made diversification easier and more accessible, but they aren’t the only option. Whether you prefer traditional methods or modern solutions, the key is to ensure your investments align with your broader financial strategy.

The past century has seen remarkable advancements in diversification strategies, from manual stock selection to the introduction of pooled investment vehicles, index funds, and finally ETFs. Each development has provided investors with more opportunities and efficiency, yet the core principle remains the same: diversification can help manage risk and improve long-term financial outcomes.

As always, do your own research, make the choices that best suit your needs, and reach out to a licensed financial adviser if you need support. Investing isn’t a one-size-fits-all journey, so find the strategy that works for you and stick to it.

Happy investing!