ETFs as an alternative to a savings account?

The popularity of savings accounts across Europe is evidenced by one interesting fact from last year. Despite the rise in share prices across European stock exchanges last year, there was a significant fall in trading volumes. This was also the case on the Prague Stock Exchange, where trading volumes fell 26% year-on-year to CZK 123.5 billion.

Europe fought high inflation by raising interest rates, which even rose to an all-time high within the ECB. The CNB (Czech National Bank) then held interest rates at 7% for most of the year, which was reflected in savings account yields. As interest rates rose, government bond yields also rose. Savings accounts and bonds were thus too attractive and investors took full advantage of this. They thus earned virtually risk-free returns on savings accounts and bonds.

While the overall return on the stock markets was much more attractive, stocks were also subject to many risk factors during the year (banking crisis, conflict in the Middle East). Overall trading volumes on European stock exchanges should increase this year - with interest rates expected to fall significantly, this will make it less attractive to keep money in a savings account and more people will possibly invest. Putting spare money aside in a savings account can be described as saving rather than investing. However, it is definitely a passive form of money management. What are some other alternatives that may be attractive when interest rates fall?

ETF funds - a trend of the last decades

Exchange-traded funds (ETFs) are investment vehicles that have become a cornerstone for many passive and active investors around the world. Their emergence has revolutionized the market and their popularity is skyrocketing. ETFs offer a wide range of benefits and options, which explains their growing popularity - the total number of ETFs has increased more than 40 times since 2000.

ETFs can generally be thought of as pools of assets such as stocks, bonds, or commodities, which are then traded on an exchange, much like a regular stock. Today, however, we can find ETFs for virtually everything. ETFs originated in the 1990s as an effort to provide investors with a cheaper and easier way to diversify their portfolios. The popularity of ETFs has been steadily growing, largely because of their transparency, liquidity, and low costs. Many new ETFs are launched every year, covering different sectors, industries, or investment strategies.

_{Total number of ETFs, source Statista}

The main advantages of ETFs include

ETF funds vs ETF portfolios, what's the difference?

While ETF funds can be thought of as collections of assets (stocks, bonds, etc.), ETF portfolios are groupings of these funds.

ETF portfolios usually work on their own without anyone managing them. This has a positive effect on their operating cost, which is lower as a result (no need to pay a manager to look after them). The investor only needs to decide which sector he or she would like to invest in and find an appropriate ETF portfolio.

The main advantage of ETF portfolios over individual ETFs is even deeper diversification. This is both between sectors (for example, Purple Trading's Global Equity ETF Portfolio invests in stocks of top companies from the US, EU, and emerging markets) and asset types (for example, Purple Trading's Balanced ETF Portfolio, which consists of 50% equity funds and 50% bond funds). By investing in one ETF portfolio, you get a decently diversified investment vehicle. One that if you invested in individual ETFs you would have to spend hours, maybe even days, putting together.

This is why ETF portfolios are an increasingly popular form of passive investment. So it's quite possible that when interest rates on savings accounts fall, many investors might reach for one of the ETF portfolios.

What to look out for when choosing individual ETFs?

1. Costs
   Compare administrative fees and operating costs. Due to high competition, the costs of managing index funds, for example, are extremely low. However, for riskier instruments such as crypto ETFs or leveraged funds, annual costs can be in the single digits.

2. Trading volumeHighly liquid ETFs are less likely to have a significant difference between the bid and ask prices. In addition, not all ETFs offer high liquidity. Before buying an ETF fund on a regular basis, first look at its volume. Low trading volume can significantly affect your price at the final sale.

3. Which type to choose?
   There are many types of ETF funds, we discuss more about them below.

What are the types of ETFs?

ETFs can be classified according to many categories. Based on domicile, there are two main categories of ETFs:

1. US (US) and

2. EU compliant (UCITS).

US funds tend to offer a wider range of assets, while UCITS funds are regulated by European standards and are often more standardised for European investors. US funds can often look more attractive at first glance and have a broader range of offerings, but unfortunately they are not available to retail investors in Europe. However, even among UCITS funds you can find what you need.
 

ETFs can be further divided into reinvestment and distribution funds. These differ in the way they process investment returns, which has an impact on the investment strategy.

1. Distribution ETFs issue investment returns to investors in the form of regular dividends or profit payments. These distributions may be used to make further investments or paid to the investor as income.
2. Reinvestment ETFs, unlike distribution ETFs, do not pay returns to investors but automatically reinvest them back into the fund. This means that the returns are reinvested in the same assets, which can lead to an increase in the value of the fund.

The choice between reinvestment and distribution ETFs depends on personal preferences regarding investment income and investment strategy. Those seeking regular income may prefer distribution funds, while investors looking to maximize capital growth may prefer reinvestment funds.