As long as there will be sell-side bankers, there will be new investment products ushered in to attract the individual investor to the pot of gold. We must begin with the requisite disclaimer that whatever is printed in this article is not investment advice, so check with your broker before making any investment decisions.
Okay. Now we are ready. ETFs per say are not new. However, the amount of money poured into them is somewhat astounding. The first ETF, the S&P SPDR, came to life on January 23, 1993. This fund currently has over $292 billion in assets under management. The second largest ETF today, the iShares Core S&P 500 ETF, began trading in May of 2000. There was a school of thought circulating among the investment world at the time that professional money managers could not outperform the market as a whole. The individual investor was inundated with a myriad of markets to invest in, including bonds, emerging markets, sectors, futures, forex. You get the idea.
Drifting back to Modern Portfolio Theory, one theoretically can equate risk to return by diversifying asset classes. As postulated by Markowitz in his 1952 article in the Journal of Finance, it essentially comes down to an allocation between cash, equities, and bonds. The allocation is tweaked as one ages. A younger person can be more exposed to the market (equities) because of the longevity of their investment horizon. The opposite is true of those approaching retirement. Circling back to the ETF, one such as the SPDR is essentially a proxy for the market as a whole.
The concept that if you cannot beat the market, be the market, has created an enormous asset class as an ETF in the manner of the S&P 500. The S&P 500 is the market, for all intents and purposes. It is the bellwether used in analysis and is considered “the market” in respect to annual return et al. Morningstar will tell you that the vast segment of money managers cannot outperform this benchmark on a regular basis. As an individual investor looking at a buy and hold longer term time horizon, have your broker look at which S&P 500 benchmark makes most sense for you. Items such as taxes, fees, service charges, etc. will come in to play. With that said, these fees are typically very minimal, especially for mutual funds like Vanguard and others.
In terms of how an ETF is defined and calculated, it is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.
The following is a selection of some of the most popularly traded ETFs:
- One of the most widely known and traded ETFs tracks the S&P 500 Index, and is called the Spider (SPDR), and trades under the ticker SPY.
- The IWM tracks the Russell 2000 Index.
- The QQQ tracks the Nasdaq 100, and the DIA tracks the Dow Jones Industrial Average.
- Sector ETFs exist that track individual industries such as oil companies (OIH), energy companies (XLE), financial companies (XLF), REITs (IYR), the biotech sector (BBH), and so on.
- Commodity ETFs exist to track commodity prices including crude oil (USO), gold (GLD), silver (SLV), and natural gas (UNG) among others.
- ETFs that track foreign stock market indices exist for most developed and many emerging markets, as well as other ETFs that track currency movements worldwide.
Have a conversation with your broker and decide if ETFs are right for you.