ETF vs. Dry Cleaning - Why ETFs are a must in most investment portfolios

When is the last time you used a dry cleaner for your kitchen towels? Despite the rhetoric aspect of this question, this is what many investors are still doing with their investments. 

Kitchen towel or cashmere jumper

When considering an investment, the first step is to identify the nature of its market. If this market is well developed, liquid and easily accessible, most likely you are dealing with a kitchen towel. This includes broad-based equity indices such as S&P500, MSCI Global as well as the government bond markets of developed countries.

On the flip side, if the market where your investment is traded is emergent, thinly traded or complex, you are dealing with a cashmere jumper. There you will find equity and bonds from emerging markets, high yield bonds and certain alternative investments.

Washing machine or dry cleaner

Kitchen towels are fairly easy to handle and extra care will usually not result in any significant benefit. For such material, a simple washing machine will do the job. By the same token, such investments are easily taken care of by passively managed vehicles such as ETFs.

Your cashmere items, on the other hand, will require special attention. Their delicate nature will typically require the attention of a specialist. This has a price but like your dry cleaner, it can save you from nasty surprises. For such investments, the use of actively managed funds is justified.

Mixing colours and reading the labels

There are instances where putting all your kitchen towels in a washing machine might lead to undesired consequences. If you have too many items of a similar colour, the risk is that your whole load will end up tainted by this colour. To illustrate this, some ETFs giving you exposure to global bonds might be biased towards one specific region or sector, which is heavily indebted. In such cases, it might be wise to distance yourself from the washing machine and opt for a more delicate and actively managed investment vehicle.

Conclusion

Actively managed funds are useful vehicles to deal with the complex bucket of your investment portfolio. They require specialist knowledge, which justifies their higher management fees. For the rest, inexpensive and passively managed funds are more appropriate.

Like a washing machine in a household, ETFs are a must-have in most investment portfolios. 

First posted on LinkedIn, February 11, 2025.