Five questions to ask before investing in an ETF

Exchange-traded funds (ETFs) have radically changed the investment landscape. This month marks 25 years since State Street launched the first ETF in Australia. Fast forward to 2026, and investors can choose from 458 ETFs, with more coming on board all the time.  

That gives investors plenty of options, but how do you know which are right for you?  

Asking five simple questions can help narrow down the choice. And rest assured, the answers can usually be found on an ETF's web page.  

Here's what to ask when deciding which ETFs to invest in:  

1. How diversified is an ETF?  

In a single trade, an ETF can give you exposure to hundreds or even thousands of investments across different markets and regions.  

Scratch the surface, though, and you'll find some ETFs are far more diversified than others. A broad global shares ETF, for example, may invest in more than 1,000 companies across a range of countries and industries.  

Others hold a much smaller number of companies or focus on a particular market, sector, or theme. It's also worth looking at how much of the ETF is concentrated in its largest holdings.  

The bottom line is to understand how much diversification you're getting. It could be less than you expect.  

2. Are you doubling up?  

Investing across multiple ETFs can seem like a sensible way to boost diversification. The catch is that different ETFs can hold many of the same underlying companies.  

Instead of spreading risk, doubling up this way can leave you more concentrated than you realise.  

The solution is to check out an ETF's main holdings (this is where the fund's web page comes in).  

If there's a strong degree of overlap, think about whether your portfolio will really benefit or if you're just buying more of the same.

3. How is the ETF managed - active or passive?  

Most, though not all, ETFs in Australia are passively managed. This means they aim to track an index or benchmark rather than beat it. They may hold all, or a representative sample, of the investments in a given index.  

For some investors, it can be counterintuitive to simply accept index returns. For these people, actively managed ETFs may be their preferred choice.  

That's fine. However, it is extremely hard for fund managers to beat the market (as measured by an index), not just once or twice, but year after year.  

The S&P SPIVA Australia Scorecard, which measures the performance of active fund managers, consistently shows that most do not beat the market. Plenty don't even match market returns.  

In 2025, for example, 70% of active global share funds earned less than market returns. It was a similar picture for active Aussie share funds. In both cases, underperformance rates were even higher over longer periods.  

Yes, some actively managed ETFs will outpace market returns. But can you pick the winners, and is it even worth trying given the abundance of passively managed ETFs charging very low fees? Which brings us to the next question...  

4. What will you pay in fees?  

A quick check of ETFs listed on the ASX shows you could pay annual fees as low as 0.03% or as much as 2.38%.  

Paying more is no guarantee of higher returns, and as a general rule, passively managed index funds charge lower fees.  

Whether you opt for index or active ETFs, fees are something to look at. Just like returns, the impact of high fees can compound over time.  

5. Does the ETF follow a theme?  

Themed ETFs that focus on small, niche areas of the market are popping up all the time. I'm thinking along the lines of the Global X Battery Tech & Lithium ETF (ASX: ACDC), the Betashares Video Games and Esports ETF (ASX: GAME), and market newcomer the Global X Space Tech ETF (ASX: MOON), which focuses on the global space economy.  

Themed ETFs can let investors back a particular industry or trend. While this may appeal to you, there are issues to be aware of.  

The niche focus can reduce portfolio diversification rather than add to it.  

The bigger downside is that themed ETFs are often launched just as interest in a particular trend is peaking. From there, things can go downhill.  

One study found specialised ETFs lost about 30% on a risk-adjusted basis over their first five years. The researchers put this mainly down to the underlying shares being overvalued when the ETFs launched.  

The upshot is to think about whether a themed ETF will really help you achieve long-term goals or if you're investing in market hype.  

What not to rely on  

The five questions I've listed deliberately overlook one key factor: an ETF's past returns.   

As the saying goes in investment circles, today's newspaper can become tomorrow's fish and chip wrapper, and few ETFs remain at the top of the leaderboard from one year to the next.  

Instead of putting a lot of weight on recent returns, look at what the ETF invests in, decide if it matches your risk tolerance and timeframe for investing, and think about whether the fund's underlying investments fit well with your broader portfolio.  

As more ETFs come on board, it's becoming more important to look under the hood of an ETF to know what you're really investing in. It's an important part of deciding if a particular ETF ticks the boxes to help you achieve your personal goals.