Warren Buffett Likes ETFs not Unit Trusts — And So Should You!

1 July 2024

When Warren Buffett, arguably the most successful investor in history, speaks, smart investors listen. Buffett's investment wisdom is legendary, and he has consistently outperformed the market for many years during his investment career. Yet, despite his unparalleled success, Buffett is the first to advise that retail investors should keep it simple and invest in ETFs.

Buffett’s confidence in ETFs became particularly evident in a 2013 letter to Berkshire Hathaway shareholders. He revealed that upon his passing, the trustee of his estate will invest 90% of his wife's inheritance in a low-cost S&P 500 index fund and 10% in short-term government bonds. This endorsement from one of the greatest investors of all time underscores the advantages of ETFs, especially over Unit Trusts (mutual funds), and is a powerful reason why investors should consider ETFs as their investment of choice.

What is a Unit Trust?

A Unit Trust is an actively managed investment fund where multiple investors’ monies are pooled together and invested, with each investor holding a set number of shares determined by the subscription entry price per share and total investment amount subscribed into the fund. A professional fund manager selects securities like stocks or bonds based on the fund’s written investment mandate contained in its prospectus. Investors buy units of the fund and earn returns if the underlying securities’ market prices rise over time. Due to active management, Unit Trusts typically charge high management fees to cover the costs of monitoring markets and conducting ongoing research on securities selected for inclusion in the Fund.

What is an ETF?

An ETF (Exchange Traded Fund) is typically passively managed to closely track a related index, comprised of securities that all trade on a stock exchange. Each ETF usually aims to replicate the performance of a specific index, like the S&P 500 or the Straits Times Index (STI), by holding a proportional representation of the securities in that index. Because they are typically passively managed, ETFs usually have lower management fees and operating expenses.

Most investors would be better off buying ETFs on the New York Stock Exchange (NYSE) through a local stockbroker rather than buying similar-focus Unit Trusts. Most the Unit Trusts offered in Singapore are high-fee active funds rather than low-fee passive funds.

Key Advantages of ETFs

• Lower Fees and Costs

One of the primary reasons ETFs outperform Unit Trusts is their lower cost structure. Here is a breakdown of the fees involved:

Management Fees:

ETFs: Typically, < 1% with most charging 0.3% or 0.5%. p.a.
(Source: https://blog.moneysmart.sg/invest/index-fund-etf-singapore/)

Actively Managed Unit Trusts: 1 - 2% p.a.

One-off Fees:

ETFs: Brokerage fees around 0.05% to 0.28% per trade, with trading fees as low as under $10. (Source: DOLLARS & SENSE https://dollarsandsense.sg/singapore-stock-brokerage-house-comparison/)

Unit Trusts:

Subscription Fee (Front-end Load): Payable to the distributor when you buy a fund, typically ranging from 1.0% - 5% of your investment. For example, a $10,000 investment with a 2% sales charge would leave only $9,800 invested.

Redemption Fee (Back-end Load): Payable to the distributor when you sell or redeem the fund, ranging from 1% - 5% of your investment.

Switching Fee: Payable to the distributor when you switch from one fund to another managed by the same fund manager, typically about 1% of your investment.

Recurring Fees:

ETFs: Lower total expense ratios (TERs). For example, iShares Core S&P 500 ETF has a TER of 0.03%. (Source: https://www.ishares.com/us/products/239726/ishares-core-sp-500-etf)

Unit Trusts: Higher TERs due to trustee, administrator, custodian, accounting, valuation provider, auditor, and other miscellaneous fees. Based on Morningstar data for funds registered for Singapore sale, the average TER of major fund categories such as US large cap growth equity and Asia ex-Japan equity funds exceed 1.8 per cent. Those for single country funds and specialist theme funds may exceed 2 per cent.

High TERs in Unit Trusts can significantly erode investment returns over time. An investment of $100,000 with an annual return of 5% would grow to $324,000 after 30 years with a 1% TER, but only to $242,000 with a 2% TER, demonstrating the substantial impact of fees.

¹Source of Unit Trust fees: Unless otherwise stated, all are extracted from MoneySense, a Singapore government agency.

• Higher Liquidity

ETFs are traded on stock exchanges, offering high liquidity. Investors can buy and sell ETFs throughout the trading day at market prices, providing greater flexibility and quicker access to funds. Unit Trusts, on the other hand, are traded at using end-of-day net asset values (NAV), and transactions can take several days to process. This difference can be crucial for investors needing quick access to their cash.

• Transparency and Simplicity

ETFs offer greater transparency compared to Unit Trusts. Because ETFs track specific indices, their holdings are publicly known and easy to understand. In contrast, Unit Trusts often lack transparency, typically disclosing only top 10 holdings with full holdings shown in stale dated half-yearly or annual reports. Their performance is also heavily reliant on the fund manager's expertise and decisions that are also rarely disclosed. Additionally, the issue of trailer fees—where distributors receive a portion of management fees—raises questions about the objectivity of financial advice given to investors.

• Ease of Access

ETFs can be purchased easily through any brokerage account, allowing investors to manage their investments independently. Unit Trusts, however, are typically bought through banks, financial advisors, online investment platforms or directly from fund management companies, often involving higher entry and exit fees. This ease of access makes ETFs a more attractive option for investors who prefer a hands-on approach to managing their portfolios.

The Verdict: ETFs for Better Investment Outcomes

While both ETFs and Unit Trusts offer diversified market exposure, ETFs generally provide a more cost-effective, transparent, simple and flexible investment option.

Follow Buffett’s Lead

If Warren Buffett, with his vast investment acumen, advocates for ETFs, it's a strong endorsement that should not be ignored. By choosing ETFs, you are aligning yourself with a proven strategy that emphasizes low costs, simplicity, and solid long-term returns. So, take a page out of Buffett's playbook and make ETFs your go-to investment choice.

Invest with SQSave for Superior Portfolio Management

If you find yourself overwhelmed by the array of ETFs available, consider investing with SQSave. Our sophisticated, AI-driven Global Portfolios not only streamline your investment decisions but also maximize the potential of your ETF investments. Leveraging advanced algorithms and cutting-edge technology, we ensure optimal asset allocation and maximised risk-adjusted returns, providing you with a seamless and intelligent investment experience.

Yours sincerely,
SQSave Investment Team

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