It’s easy to get lost watching the daily swings of ETF prices, as if a hypnotist were asking you to fixate on a pendulum moving back and forth. After all, when the price goes up, you make money, on paper at least. And when the price goes down, well, you lose.
As long-term investors, we try to discourage focusing on these short-term swings. After all, if you’re investing for the long haul, daily price swings aren’t going to give you much besides agita.
Besides, the entire performance story doesn’t simply lie in price changes; it’s also in the little things, like the fees you pay, the dividends you receive, and the less visible factors that can impact your long-term returns.
Here's how to evaluate ETF performance without getting distracted by the daily market noise.
Why invest in ETFs
Before thinking about performance metrics, it’s important to understand why exchange-traded funds exist in the first place. These investment vehicles revolutionized investing by democratizing access to broad markets. Instead of selecting individual stocks and hoping for the best, investors can buy a single fund that holds a multitude of companies.
The ETF structure offers considerable benefits in terms of diversification. If a single company in a broad-market ETF faces a massive scandal and its stock plummets, the overall portfolio might barely register the damage. The collective strength of the other holdings can help act as a shock absorber in an effort to minimize volatility. ETFs also offer a similar level of diversification to a mutual fund, but with the trading flexibility of an individual stock.
Knowing why to buy ETFs is only half the battle. Knowing how well they are doing is where the real work begins.
The metrics that can drive ETF performance
In evaluating ETF performance, it’s important to build a comprehensive dashboard that includes more than just price appreciation.
The slow leak: expense ratios
Every ETF charges a management fee, which is also known as the expense ratio. This is the percentage of your investment that goes toward paying the manager’s expenses – literally keeping the lights on.
Think of the expense ratio as a slow leak in a tire. A large fee may flatten returns over time, even if the underlying stocks perform impressively. When comparing two similar funds, make sure to look at the fee structure.1 A fund charging 1% annually might not sound expensive, but over a 20-year investment horizon, that percentage point may consume a portion of your wealth creation if your returns don’t keep pace.
The cash back: dividend yield
Many companies return a portion of profits directly to investors in the form of dividends. When an ETF holds dividend-paying companies, it collects the payments and passes them on to investors.
The dividend yield is rather the financial equivalent of a cash-back rewards card. Even if the ETF's share price trades sideways for the year, a strong dividend yield means that the investment is still generating income. Reinvesting those dividends makes it possible to buy more shares, which then produce their own dividends. It is a compounding machine that many investors completely overlook when gazing at a flat price chart.
The friction: trading fees and tracking error
Every time an ETF manager buys or sells stock to mirror an index, there is friction.
First, trading isn’t free. It incurs fees. While many brokers now offer commission-free trading for customers, the fund itself incurs costs when shifting its internal holdings.
Second, consider tracking error.2 Some ETFs are designed to perfectly mimic a specific index, like the S&P 500. When that doesn’t happen, you get tracking error — the gap between the index's performance and the ETF's actual performance. If an index goes up 10% but your ETF only goes up 9.5%, that 0.5% gap is tracking error. If you choose an ETF that tracks an index, it’s important to choose one with tight steering. Otherwise, you may find yourself drifting too far off course.
The shield: tax benefits
Taxes are considered the single biggest threat to long-term wealth creation. Fortunately, the unique way that ETFs are structured makes them extremely tax-efficient.
First of all, in general ETFs have relatively low portfolio turnover, so they should generate few realized gains. With lower turnover comes a longer holding period, which means that on those occasions when there are gains, they should be taxed at the lower long-term capital gains rate for those held longer than a year. ETFs also distribute significantly fewer (sometimes zero) capital gains to their shareholders compared to mutual funds, so investors have a capital gains tax liability only when they sell their ETF shares at a profit.3
When investors sell their ETF shares, the ETF provider often exchanges the securities directly with a large institutional investor rather than selling the stock for cash. This type of in-kind transaction allows the fund to remove low-cost basis securities (which create the highest capital gains tax liability) without triggering a taxable event for the remaining ETF shareholders. Lower tax liability improves ETF shareholders’ performance metrics.
The ultimate metric: total return
Take share price appreciation, add potential cash from the dividend yield, subtract the expense ratio, and account for general tax efficiency. This gives you the total return, which is the king of investment metrics.
At the end of the day, we believe total return is the only number that truly matters. This figure represents the actual, realized growth of your investment. The financial press loves blaring headlines about price changes because those are numbers that move fast and grab attention. However, seasoned investors maintain a relentless focus on total return because it gives them the complete picture of financial performance.
The long haul: why time horizons matter
Now total returns are great, but for long-term investors, it’s even better when you look at them over extended timeframes.
That’s why most ETF fact sheets group returns into 1-year, 3-year, 5-year, and 10-year intervals. It can not only validate the ETF strategy, but these intervals also help investors avoid the deception of short-term volatility.
For example, a 1-year return is heavily influenced by immediate economic circumstances. A sudden political event, a temporary supply chain disruption, or an unexpected interest rate hike can make a fantastic ETF look dreadful over a 12-month stretch.
When you widen the aperture to 3-year and 5-year performance figures, that one-year stretch may look more like a blip than anything else. You can start to see how the fund handles business cycles, including both expansions and mild corrections.
Now, the 10-year marker is the proof in the pudding. Over a decade, short-term noise fades away entirely. What remains is an undeniable demonstration of the fund's strategy, the actual impact of its expense ratio, and the compounding power of its dividends. Measuring performance across these specific milestones encourages investors to evaluate their holdings as long-term wealth vehicles rather than short-term lottery tickets.
The Takeaway
Evaluating an ETF is not always about what the ticker says that minute, day, or week. It’s vital to account for the fees draining your account, the dividends adding value, and the structural friction that can put a drag on performance.
Shifting the focus away from daily price swings and prioritizing total return can help you avoid knee-jerk reactions to headlines and lean into your portfolio’s purpose.
If you want to explore investment vehicles built with these core principles in mind, take a closer look at our funds. Wealth is built by holding high-quality investments over the long term. Understanding exactly what you own and how to evaluate investment performance is the very first step of that journey.
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