Are your financial goals to make money with passive, low-cost investments? Do you struggle picking the direction of individual stocks, or feel overwhelmed by the task of having to choose the right stock to make money with? Then I would suggest you look to invest in Exchange Traded Funds (ETFs) – the upcoming investment market that will dominate portfolios through 2014 and into the future.
Exchange Traded Funds, or ETFs, have been available in the US market since 1993 and have been the strongest growing investment vehicle of all time. But not in the sense of a “Bubble” such as Bitcoins or Tulips. In Australia, their predominance has started to increase as accessibility to global markets has pushed demand for this exciting product line.
Australian Stock Exchange
The Australian Stock Exchange offers over 90 Exchange Traded Products. These range from locally derived index products, to International, Commodity, Fixed income, Currency and Cash products. Bottom line, if you can think of something to invest in, then between both the Australian and US ETF markets, you will find a product to trade.
World renowned investor Warren Buffett, who is valued at $60billion according to Forbes magazine, has been reported to have left instructions that upon his passing, his wife should invest in index funds. In particular, the S&P500 index which represents the top 500 companies listed in the US stock markets.
So why would one of the world’s richest people and most successful investors be advising to invest in index funds over specific company’s?
The answers are the same reasons why you should be considering ETFs for your investment portfolio. Let’s take a look at why.
Reason #1: Risk management
Buying an ETF such as STW (SPDR S&P/ASX200 Fund) or IVV (iShares S&P500) will give you exposure to the broader stock market. Although stock markets can fall, and a crash can have a devastating effect, buying the stock market as a whole reduces the risk of an individual company falling.
Let’s say you bought 10 stocks in different companies and one of those companies released an exceptionally negative earnings report (the recent QANTAS report comes to mind). That stock price might fall heavily, and you will lose value in your investment.
However, although the market ETF such as STW might decline slightly, it is not going to decline to the same percentage as QAN for example, all other stock prices being equal. Therefore, you reduce your investment Risk.
Reason #2: Reduce costs of investment
Using the same portfolio example, if you buy shares in 10 different companies, you will have brokerage fees for each one of those transactions. Alternatively, if you buy the equivalent amount of capital value in an ETF such as STW, you will have only the one brokerage transaction.
This could be a significant savings, especially over time. Providing you with more capital for investment, rather than being spent on costs.
Reason #3: Less time for research
If you are tracking 10 different companies in your portfolio, from various industries, you will need to spend time evaluating the various reports and announcements that will be made for each of these. You will need an understanding of how to evaluate a company fundamentally as well as technically.
By choosing specific ETF’s, you don’t need to form an opinion on numerous companies, but instead can form an opinion on a broader industry. Fundamental changes in an industry are usually a lot slower than individual companies.
Reason #4: Profitability
ETFs such as STW provide dividend payments as well as potential capital gains. With a dividend yield of 4.19% per annum (based on prices at time of writing), and a gain of 14.2% in 2013, investing in STW in 2013 certainly provided a healthy return compared to the Risk of investing in individual stocks.
Considering STW represents 200 companies, of which not all of them actually gained in 2013, or even met the performance of the leading market index.
Reason #5: Global Diversification
Did you see the boom of China unfolding in front of you? Did you wish you had put some money into that market but just didn’t know how? Or maybe you had formed the view that Gold would rise and the risk of investing in futures contracts scares you.
Through the ASX, you can invest in ETFs that represent nearly every global market. Europe, Asia, China, Emerging Markets, Bonds, Gold, High Dividend stock, leading market indices, or sector specific such as Financials or Resources. And if you tap into the US ETF market, you can gain access to leveraged ETFs and those that profit if the stock market falls (referred to as being Short).
Diversification of ETFs
This amazing diversification of ETFs available can help you to strategically establish a portfolio that provides lower Risk, dividend income, and the potential for capital gains at reduced costs and for less time management.
Investing in ETFs presents the same Risks that investing in stocks provides. If the broader stock market declines, then the value of the underlying share price will decline. At the same time, if you are investing in US listed ETFs, you will need to consider fluctuations in currency as this could change the value of your investment.
There are strategies to help alleviate these Risks, including adopting a Currency hedge position (and yes, there is an Australian dollar ETF listed in the US), and as previously mentioned, you can purchase a Short ETF position if you believe the stock market has the potential to fall.
Managing Risk is the key element to successful investing, which ETFs provide a greater opportunity than simply buying a diversified share portfolio.