What to consider when choosing tax-free ETFs

SINCE the launch of tax-free accounts, many people have turned to banks to safeguard their money in a tax-free savings account. While some people may indeed hold these accounts with a long-term view, it’s very important to understand what they’ll get back.

Tax-free savings accounts offered by banks come with fixed interest rates. Given the limits imposed, it’s highly unlikely those putting money into these products will be able to beat inflation.

While banks will have different interest rates, it’s probably a good idea to compare returns with tax-free investment offerings such as tax-free exchange traded funds (ETF).

When choosing an ETF or unit trust to invest it in, it’s important to keep costs at the forefront of your strategy. Unit trusts are similar, but because many are actively managed, their fees tend to be slightly higher.

When comparing platforms, look at the total expense ratio (TER). This is the cost of buying the ETF. Some providers charge monthly account fees on top of the TER, so be sure to compare this element too. You can find a full breakdown of the TER by looking at the fund’s fact sheet.

Because ETFs span a wide range of indices that track all manner of asset classes, it’s important to understand what the underlying asset is.

ETFs track indices. An index is a measure of the performance of a group of securities that fulfil certain requirements.

For instance, the Absa NewFunds S & P GIVI SA Industrial 25 ETF replicates the performance of the S & P GIVI SA Industrials Index.

This particular index tracks the performance of the 25 biggest industrial companies listed on the JSE. In this case, the index companies are selected based on their intrinsic value and low volatility.

Other indices might be built around the underlying companies’ market capital, or environmental factors.

The CoreShares Green ETF, for instance, is based on Nedbank’s Green Index. Underlying factors need to fulfil certain environmental and liquidity requirements.

It’s important that you understand how the index is composed before you invest there.

You’ll also get an indication of the fund’s particular risk profile and that will help you shape your asset allocation accordingly.

Anyone with a long-term view (10 years or more), might be interested in riskier ETFs as they have time to ride out market volatility.

It’s true that past performance is not an indicator of future performance, but investors with a long-term view should think about market expectations with a very long-term view.

Fact sheets will give you information about the fund, including objectives and aims, as well as what index it tracks.

Fact sheets also include an indication of the fund’s performance since inception.

Pay special attention to the information about income distribution – that would be dividends paid out.

Remember that ETFs can be traded like shares intraday – so you don’t have to wait for the end of the day before your sell instructions are actioned.

While ETFs are considered to be diversified instruments, having a strategy in place, and reviewing it every now and then, is important.

You might want to switch things around when a new tax year rolls around.

The most important aspect of tax-free investing, regardless of what you’re investing in, is to make sure that you don’t exceed your investment limit, which is R33 000 per tax year.

This could attract penalties.

● Tsamela is the piggiebanker.com . unnecessary founder of