ETF - The Basics
When it comes to investing there are thousands of options to choose from. Stocks, bonds, mutual funds, treasuries, currencies, commodities, real estate… the list goes on. Here at Super Monedero our goal is to cut through the noise and provide clarity on the financial topics which are most important to you and your family.
As it relates to investing and saving for retirement, one topic which cannot be ignored are Exchange Traded Funds (ETFs). In this article we will explore what ETFs are, how they work, what types of ETFs exist, and a few to explore as you are getting started. If you are new to investing and are not comfortable with how stocks or mutual funds work, we recommend you read our article here covering mutual funds before diving into the wide world of ETFs. The fundamentals explored in that article will be crucial to understanding how ETFs work and why they are many times preferable to mutual funds.
To fully understand how ETFs work, it is important to understand why they are called Exchange Traded Funds.
An exchange is a place where financial instruments are traded. A financial instrument could be anything from a share of Apple stock to a bond issued by General Electric. In the “good old days” exchanges were where stock traders would gather in pits and physically trade stocks and bonds using hand signals with other traders. Anymore, almost everything is done electronically using quote screens and electronic trading platforms which connect buyers and sellers. Popular exchanges are the New York Stock Exchange and NASDAQ in New York, The Chicago Mercantile Exchange in Chicago, The London Stock Exchange in London, and the Japan Exchange Group in Tokyo. All of these exchanges list financial products that investors can buy and sell.
This act of buying and selling is called trading, and the critical element to ETFs is that they are traded daily on exchanges around the world. This is one of the core differences between ETFs and mutual funds. When you buy a share in a mutual fund you are buying shares from the fund company - in this way the fund company is effectively acting as the exchange. When you buy an ETF you are buying shares from another investor who would like to sell their interest in the fund. For every buyer, there must be a seller. When a buyer and a seller agree upon a price for the ETF’s share, this is how the price of the ETF is established.
This all happens at the speed of light, as there are on average 69 million shares of the SPDR S&P 500 ETF traded daily.1 Volume is the term traders use for the numbers of shares being traded daily. Higher volume means the cost of trading the instrument should be cheap - more to come on that later.
The final element to understand is that ETFs are funds, meaning they are collections of stocks and bonds which are chosen by a fund manager. Again, consider reading our article on mutual funds if you would like a deeper explanation on how funds and fund managers operate.
Why ETFs Are So Popular
ETFs have become one of the most popular investment vehicles available today. There are two critical reasons why they have seen such a prolific boom since the year 2000:
- Lower fees As we mentioned, it is not uncommon to see trade volume approaching 100 million shares per day on popular ETFs. With this large trade volume, comes lower fees on a per trade basis. The exchange manages the buying and selling of shares, so there is no requirement on the fund company to manage the inflow and outflow of investment - as is required with mutual funds. The net impact to investors is generally lower fees when trading ETFs than mutual funds.
- Higher liquidity Liquidity is a technical term for how easily it is to sell an investment. The most liquid asset out there is cash and ETFs which have huge volume (like SPY) are a close second. With millions of traders interested in buying and selling these ETFs on a daily basis the transaction is completed almost immediately and you will see cash in your brokerage account as soon as the transaction is complete. Mutual funds are notorious for having slow turnaround times when investors would like to sell their shares and get their money back.
Types of ETFs
Much like mutual funds, there are a huge number of ETFs available to investors. In 2016 there were just under 5,000 ETFs available to investors and this was up from just 276 in 2003.2 The type of ETF which is right for you really depends on your investment goals. Are you looking to invest in the overall market? Are you trying to invest in a specific industry? Are you hoping to invest in currencies, commodities, or bonds? Are you only looking to invest in companies that are working on human rights and conservation issues?
If the answer is yes to any of the above questions - there is an ETF for you. Let’s explore some of our favorite ETFs and what makes them unique.
SPDR S&P 500 (ticker: SPY)
The classic ETF in many minds is the SPDR S&P 500. This ETF seeks to mimic the movement of the S&P 500 and is a great way for beginner investors to capture “the entire market” with just one investment. With an expense ratio of just 0.09%, it is a very cheap way to gain diversification within a portfolio.
Schwab U.S. Large-Cap Growth ETF (ticker: SCHG)
If growth is what you are after, consider the Schwab US Large-Cap Growth ETF. This ETF invests in large-cap stocks which have the highest potential for growth. You will find Apple, Amazon, Facebook, and other tech-oriented stocks within this ETF. The expense ratio is just 0.07% and the ETF has returned 13.78% year-to-date. Past performance is not always indicative of future results - but that is not a bad bang for your buck.
Vanguard High Dividend Yield Index Fund ETF (ticker: VYM)
For retirees or investors that are looking for dividend income, this can be a great option. This ETF only invests in established companies which have a proven track record of paying dividends to shareholders. These dividends are then passed along to shareholders of the ETF. Current holdings include Microsoft, Johnson & Johnson, Exxon Mobile, Wells Fargo, and Pfizer. With an expense ratio of just 0.08% this a good ETF for investors looking for income during retirement.
SPDR Gold Shares ETF (ticker: GLD)
Looking to invest in gold but don’t want to buy physical gold? This gold shares ETF from SPDR has become increasingly popular in recent years. The ETF invests directly in gold bullion and charges a modest 0.40% expense ratio to investors.
iPath Bloomberg Commodity Index Total Return ETN (ticker: DJP)
This ETF seeks to track the Bloomberg Commodity Index and gives investors exposure to physical commodities like oil, natural gas, grains, metals, and livestock. The expense ratio is bit high at 0.75% but for investors looking to add commodity exposure it can be a good option. Always keep in mind that when investing in commodities, volatility tends to be higher than is seen in the general stock market. If you are risk averse and don’t like volatility, it is best to avoid gold and commodities in general.
S&P 500 Catholic Values ETF (ticker: CATH)
Here is an interesting one, as this ETF only holds stocks within the S&P 500 which have business practices that adhere to the Socially Responsible Investment Guidelines of the U.S. Conference of Catholic Bishops. Companies which do not adhere to these principles will not be invested in by the ETF. If you are Catholic and want to feel good about what your money is supporting, this could be a good option. This is just one example within a large world of ETFs which are targeting socially responsible investment.
Robotics and Artificial Intelligence ETF (ticker: BOTZ)
This is another thematic ETF which is specifically aimed at companies which are on the cutting edge of robotics, artificial intelligence, machine learning, and deep learning. With an expense ratio of 0.68% it is a bit higher than you will find on index-targeted ETFs, but it is a good way to capture growth within this very specific, and rapidly growing, sector of the economy. In general, as the target of an ETF becomes more specific the expense ratio will increase. This is due to the fact that more research is required from fund managers as they pick investments.
The point of highlighting these ETFs is not to give specific investment recommendations or to show you where you should put your money. Rather, the point is to show you that the ETF world is massive and regardless of what you are trying to achieve with your investments there is a likely an ETF to match. Great resources for doing research on specific ETFs are sites like Yahoo! Finance, MorningStar, or MarketWatch. These are all free and will allow you to view an ETFs historical performance, see what stocks and bonds make up the fund, and see the expense ratio.
Regardless of the investment option you choose, we will be with you every step of the way here at Super Monedero.