What is ETF investing?
Let’s explore the potential of ETFs, and
look at specific examples.
As this chart of the growth in total net assets
of ETFs shows, it is one of the most popular
financial innovations in recent decades.
What does the acronym ETF mean?
An ETF is an Exchange Traded Fund.
Exchange traded means that ETFs are bought
and sold like stocks.
They are continuously traded while stock markets
are open, and you can invest in them through
a broker account.
Fund means that you are spreading your investment
money into baskets of many different securities.
ETFs appeal to investors who don’t believe
that active management is helpful to the performance
of their investments.
Personally, I use a mix of active investing
and passive investing, in about a 50/50 split.
Active investing is also called “stock picking”:
trying to outperform the overall stock market
by buying individual stocks that you strongly
believe in.
Passive investing is the opposite: not believing
you can outperform the stock market, and choosing
to just “follow the index”.
In my case, I use ETFs for the passive part
of my portfolio.
I am not suggesting that you should do the
same, but want to be fully transparent about
my actual investment choices.
Here’s the list of individual stocks that
I own.
Two of them have been real superstars over
the years (one in biotech, the other in software):
they have gone up 10 times in value since
I bought them!
Two others have been a total loss: the companies
went bankrupt and shares in the companies
are now worthless.
For the other stocks in my investment portfolio,
some share prices are down since I bought
them, others are up.
Thanks to the amazing performance of my two
superstar stocks, I have done pretty well
overall, but my “average performance”
is really a mix of a few extremes.
Active investing can feel like a rollercoaster
ride!
On the passive investment side, I own six
ETFs.
ETFs have scale, which is something that most
individual investors lack.
Most of the ETFs that I invested in consist
of equity (stocks), one of them of bonds.
As these are “baskets” of securities,
the swings in value have been more modest,
and the funds have gone up between 15% and
85% in value, in line with the overall market
in the last five to ten years.
Just like individual stocks, ETFs can rise or fall in price,
and may or may not pay a dividend.
Let’s get more specific, and look at the
S&P 500 ETF.
The S&P 500 is one of the most commonly followed
equity indices, and many consider it to be
one of the best representations of the U.S.
stock market.
The top holdings in the S&P 500 ETF are big
names like Microsoft, Apple, Amazon and Facebook.
And yet, the top 10 holdings form just over
20% of the total.
Let’s review the small print.
The Total Expense Ratio for this ETF is just
0.07%.
Total Expense Ratio is basically the management
fee plus other expenses expressed as a percentage
of the fund’s total net asset value.
The distribution type is quarterly, which
means that income received by the ETF (such
as dividends) gets passed on to investors
on a quarterly basis.
The methodology is “optimized” (as opposed
to “replicated”).
Optimized means that the ETF has taken a bit
of a shortcut by not holding each and every
of the index securities, but only a subset.
Replicated would have the ETF holding all
index securities in the same weight as the index.
The product structure is physical (as opposed
to “synthetic”).
Physical means the fund buys the actual underlying
securities in the index.
Synthetic means that the fund gains exposure
to the securities by buying derivatives such
as swaps, which would introduce counterparty
risk.
The Emerging Markets ETF provides an opportunity
to invest in a broad range of emerging markets
companies, based in countries such as China,
Korea, Taiwan, India and Brazil.
An interesting fact here is that the top 10
holdings consist of individual companies such
as Alibaba, Tencent, TSMC and Samsung, but
also an ETF within an ETF.
The Total Expense Ratio is .75%, which is
higher than the S&P 500 Total Expense Ratio
of .07%, but still much lower than trying
to construct
a do-it-yourself emerging markets investment portfolio.
The Clean Energy ETF focuses on a specific
industry sector, rather than replicating a
diversified index.
The Clean Energy ETF invests in 30 global
companies.
This is a replicated ETF: it holds each of
the index securities, rather than just an
optimized sample.
Active investing in individual stocks, and
passive investing through for example ETFs.
Both can be exciting, and could make you financially
wealthier.
Both have risks, always be aware
that you could lose significant amounts of money when investing.
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