I am aware that for the past few posts where I used data to test for the validity of financial sayings, some of you guys actually didn't know the difference between stocks, bonds, etfs, index funds, mutual funds! This is indeed my bad as I was so caught up with looking at the data I forgot to educate.
So, today, I shall be looking at an etf as the first part of my "Going back to the basics" series. I will also look at the some metrics that we can use to evaluate the financial instruments for each series.
By definition:
An exchange-traded fund (ETF) is a type of security that involves a collection of securities—such as stocks—that often tracks an underlying index.
- Investopedia
An Exchange-traded fund (ETF) is an investment fund operating on the stock exchange holding assets such as stocks, bonds or commodities. These funds track a specific index and accordingly will design its basket of securities.
- Wallstreetmojo
As we can see from the definitions, the keywords are:
1. Track an index
2. Involves a collection of securities/ holding assets such as stocks, bonds etc.
So... what is an index?
An index is a benchmark that we use to gauge/measure the current conditions of a market (Example would be the S&P 500 (US Large-cap Market) and the STI Index (Singapore Large-cap Market)) If a country's index is doing well, it can be used to tell us that the country's market might be doing well as well.
So, effectively, ETFs tracks the underlying index by holding multiple stocks/ bonds in that index to replicate the performance. Furthermore, an ETF also acts similar to a stock in the sense that you can buy ETF on the stock exchange during trading hours.Let us take a look at the advantages and disadvantages of this financial instrument:
Advantages of ETFs:
1. Quick diversification, when you buy an ETF, you would buy into the stocks that are under that ETF (STI ETF would grant you access to 30 stocks in the STI index)
2. Traded like a stock - Increased liquidity
3. Lower fees - As ETFs are passively managed, there are lower expense ratios (Lower management fees, no loading fees)
4. Reinvested dividends - ETFs' dividends are automatically reinvested
Disadvantages of ETFs:
1. Exposure - You would only have exposure to the stocks in that particular ETF (example: if you buy the S&P 500, you won't have exposure to the mid-cap and small-cap stocks in the US market or even to other countries' stocks)
2. Lower dividend yield - As the ETF would take into consideration the entire index, it would have a lower dividend yield compared to other portfolios focused on high dividend yield instruments.
3. Cost is higher compared to picking your own stocks - This is as ETFs have an additional management fees compared to stocks
So, how do you know if that ETF is THE ONE for you? I will be looking into the key things that you should look out for in an ETF:
1. Expense ratio (Lower better):
The S&P 500 indexes has 3 ETFs (SPDR, VOO and IVV). SPDR has an expense ratio of 0.0945%, VOO has an expense ratio of 0.03%, IVV has an expense ratio of 0.04%. As an example, if you put in $1000 into the IVV, you would get $999.60 worth of ETFs.
2. Tracking error (Lower better):
You would want the tracking error to be as low as possible so that if the index rise by 10%, your return should be as close to 10% as possible. Imagine if the index rose by 10% and your return was only 9%
3. What is the ETF tracking? (Underlying index):
There are quite a high number of ETF available in the market. Hence, the ETF that you buy should be inline with your investment needs (Dividend focused? Property focused? Emerging Market focused?)
4. Asset Under Management (AUM):
A smaller ETF would have a higher chance that it might be closed. You might be forced to sell at a loss if that happens.
5. Liquidity (How fast you can sell/ buy the ETFs):
A higher liquidity would allow you to sell off your ETFs in a faster period of time.
My personal portfolio:
ETFs plays quite a big portion of my portfolio; In particular, the S&P 500 (VOO) and the NikkoAM - STC Asia REIT ETF (CFA on SGX). This is as I believe that in the next 10 years, the US large-cap companies would continue to dominate the global consumers' market. The CFA is a Reits ETF (will explain that next time) that aims to replicate the FTSE EPRA/NAREOT Asia ex-japan NET Total Return REIT index. It includes the REIT from Singapore, Hong Kong, Malaysia, China and Indonesia. It aims to deliver 5% dividend yield annual. I bought into this ETF as I believe that properties in Singapore and Hong Kong (Which this ETF is heavily skewed to) would increase in value and this etf would act as a dividend giver in my portfolio.
With that,
I end the first of this new series.
Stay vested, Stay frugal my friends,
Dionysius
Sources:
1. https://www.investopedia.com/articles/exchangetradedfunds/11/advantages-disadvantages-etfs.asp
2. https://www.investopedia.com/terms/e/etf.asp
3. https://bluehavencapital.com/how-to-choose-the-right-etf-for-you/
4. https://www.benzinga.com/general/education/17/09/10028981/what-to-look-at-when-evaluating-an-etf
5. https://etfdb.com/etf-education/five-essential-tips-for-analyzing-etfs/
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