What are ETFs and How To Invest with ETFs


Exchange Traded Funds (ETFs) are a great way for investors to diversify their money from their regular brokerage account.  (The alternative would be to have a separate account with a mutual fund company.)  This allows you to have a single IRA account, for example, and invest both in individual stocks and index mutual fund-like assets.  ETFs are also a way to invest in specific sectors of the market since there are ETFs that track most market segments.  Finally, ETFs tend to have lower fees than all managed mutual funds and even most index mutual funds.  Since the fees you pay can greatly affect your outcome, ETFs are a smart way to invest for long periods of time.

Buy the SmallIvy Book of Investing, Book 1: Investing to Grow Wealthy at https://www.createspace.com/4306997
The SmallIvy Book of Investing, Book 1 BUY A COPY

The first ETF that existed was the Standard and Poor’s Depository Receipts (SPDR)s, which went by the name “Spiders.”  This ETF invested in all of the companies that were in the S&P 500 index, which is a group of 500 of the biggest and most dominant companies in the United States.  By purchasing shares of Spiders, investors could invest in all of these companies and track the performance of the S&P 500 index.  Given that less than half professional mutual fund managers beat the S&P 500 over long periods of time even before fees are taken out, this was not a bad way to invest.

With the huge success of Spiders, the Small-Cap Spiders and Mid-Cap Spiders were soon created.  These tracked small company stocks and mid-sized company stocks, respectively.  Today, with investments in just Spiders and Small-cap Spiders, an investor could create a well-diversified portfolio of US stocks with very low fees.

After Spiders, other ETFs started to be created.  The DIAs (or “Diamonds”) were created that track the Dow Jones Industrial Average.  Then, sector ETFs were created that invested in all of the companies within a certain sector of the market.  For example, there are ETFs that track healthcare, utilities, retail, transportation, and basic materials.  This allows you to pick specific sectors of the market you think will do well.  For example, early in a bull market technology stocks might pick up as businesses start to upgrade their business accounting systems.  As things really start humming, basic materials might start to do well.  During down periods, consumer staples would be the place to be since these are things consumers need to buy no matter what.

Finally, there are also ETFs that are designed to go opposite the market.  These are called “Short ETFs.”  You might buy these ETFs if you think the market is about to take a tumble since as the market falls these ETFs will rise in price.  This would also be a good way to protect a portfolio if you just wanted to lock in your gains and sell during a later year to delay or reduce taxes.  Note that there are also ETFs called “Ultra Short ETFs” that are designed to go up two or even three times as fast as the market goes down, but these are poorly designed.  If the market zig-zags on its way down you can actually lose money investing in these due to the way they are designed to match double the daily change in the Index rather than the long-term value change.

Buying ETFs is just as easy as buying shares of stock.  You simply pick out the ETF and then buy it through your regular brokerage account just as if you were buying an individual stock.  Each ETF will have its price listed on the stock exchange (usually the American Stock Exchange) alongside the individual stocks.  Each ETF will also have a ticker symbol just like an individual stocks (Diamonds, for example, have the symbol DIA.)

So what is the best way to use ETFs in your investing?  In general you want to have a portion of your portfolio diversified (invested in a lot of different things).  When you first start investing you may want to just invest in a few individual stocks (assuming you have a separate retirement account that is invested in mutual funds).  As you start to build wealth, however, you’ll want to shift a portion to ETFs to reduce the risk of a significant loss.

Because large stocks and small stocks tend to do well at different times, holding relatively equal portions of each is a good idea. Also, smaller companies tend to do better over long periods of time while large companies tend to be more stable, so holding a greater percentage in small-cap stocks when you are young and then shifting to a larger percentage of large-cap stocks when you’re nearing retirement is wise.

So, you might put 70% into the Small-Cap Spiders and 30% into the regular Spiders when you were starting to invest at 20 and then shift to 70% regular Spiders (or maybe 35% Spiders and 35% Diamonds) and 30% Small-Cap Spiders when you were 60. You would also build up a portfolio of fixed-income assets like bonds and high yielding investments like dividend paying stocks and REITs as you approached retirement. A portfolio for someone who was 60 might therefore be 50% bonds and dividend paying stocks, 35% Spiders, and 15% Small-Cap Spiders.

For example, you might start out by purchasing shares in 3-5 stocks that you consider to be the “best of breed” in each of 3-5 different sectors.  You might then decide to purchase an ETF (a Small-Cap Spider would be a good choice if you are young and have a long time to invest).  You might have somewhere between 10% and 20% of your investments in the ETF with the remainder in your individual stock selections.

You would keep investing, building the positions up to the 500-1000 share range and adding to the ETF to keep it in proportion until you had maybe $100,000 in your portfolio.  If you had a stock that did well, you might now have  one stock position worth $30,000 to $40,000, others in the $15,000-$25,000 range, and then maybe $20,000 in your Small-Cap ETF.

At that point you might want to cut back on the large position, maybe selling half, and buy into the Large Cap Spider or a combination of Spiders and Diamonds.  You would keep investing regularly from your paycheck and keep shifting funds from your individual investments as they grew too large to withstand a loss of the whole position.  This would continue until you were well into your forties and hopefully had a portfolio worth over a million dollars with maybe $500,000-$750,000 in ETFs.

In general it is not worth using the sector ETFs because it is very difficult to determine which sector will be hot in the future.  You will usually end up buying in when it has already been bought up, causing the price to be high, and then miss out on another sector that is doing well.  It is also usually not worth buying the short ETFs, even if you think the market is going to swoon, because rallies often last a lot longer than you think they will.  The one exception is if you just want to lock in your gains but not sell because you want to delay the taxes.  In that case you might buy into a short ETF to offset any movements in the long ETFs you own and then accept the fact that your portfolio value will not grow until you close the short position.

ETFs can be a great way to diversify in a regular brokerage account.  They are also much cheaper than mutual funds, adding to your long-term gains.  They belong in the portfolio of virtually any investor.

Contact me at VTSIoriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Please, Please, Please Get Out of Bonds


On a good day, bonds underperform stocks.  On a bad day, when interest rates start to rise, fixed income assets fall because of the rising rates, and companies start to go bankrupt because of the decline in industrial activity caused by the rising rates, bond investors get killed.  Add to that a little inflation, and you really have a lot of pain and suffering in the bond market.

We are entering one of those times.  Bond yields are insanely low because the Federal reserve has kept its rates so low for so long.  The economy is slowing as the Affordable Care Act starts to be implemented in earnest and consumers are starting to realize how much a bite it will take out of their wallets.  And yet, inflation is starting to roar with food inflation up about 20% this year due to all of the money the Federal Reserve has been printing that it had hoped to be able to keep in the bank vaults.

This is no time to be anywhere near a bond or anything that looks like a bond.  Equities will help protect you against inflation since the companies will just raise their prices as the dollar becomes worth less than it was before.  Equities will decline initially as interest rates rise and the economy slows, but eventually equities will be the only place to be for an inflation hedge.  (OK, real estate will work too.)

And while you’re at it, lock in your mortgage and any other loan while we have these insanely low rates.  We may be about ready to revisit the double-digit rates of the early 1980’s.  We’re in for a bumpy ride – strap in.

Buy the SmallIvy Book of Investing, Book 1: Investing to Grow Wealthy at https://www.createspace.com/4306997
The SmallIvy Book of Investing, Book 1 BUY A COPY

 

 

Contact me at VTSIoriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The Airlines Are Gouging You. Let Them Know You Know.


As anyone who reads this blog knows, I’m a big free enterprise advocate.  Still, there are certain businesses where free enterprise just isn’t working, or perhaps it just can’t work for some reason.  One of those areas is airlines.

Airlines were heavily regulated through the 1970’s, and despite the government setting prices, or perhaps because of it, it was typical for flights to cost $1000 or more.  There were just a few big airlines and little competition since the prices were basically the same no matter the airline you flew.  Note that this is fairly typical in a regulated industry where the companies in the industry will act like the regulations place a significant burden on them and yet they actually like the regulations because they have the resources to comply but the high costs of compliance keep competitors out of the market.  Consumers think the government is looking out for them but really the effect is to keep prices high and service quality low because of the lack of competition and the ability to blame everything on the regulations.

Then came deregulation and airlines like Southwest in what I like to call the golden age of air travel.  Airlines like United, American, and Delta always seemed elitist with their first class passengers who were allowed to board early even though they were at the front of the plane and everyone else would need to traipse by them.  They also had the little curtain so they wouldn’t need to look at the chattel behind them.  They even had their own restroom so they wouldn’t need to pee with the common folk.

Part of what always gulled me (and still does) is that a lot of the people sitting there in first class were people working for the companies of which I was a shareholder.  I was the owner of their company and they were the employee, and yet they were using my money to fly first class while I was stuck in coach.  I’m sure that most of the people in first class are either people flying with a business paying for their tickets or those annoying people who go up and ask for an upgrade before the flight, many of whom are also flying for business and therefore have a lot of airline miles that I paid for.  After all, there can’t be that many people stupid enough to pay an extra $1000 for china dishware and “free drinks”, can there?  Anyone out there fly first class and actually pay for it?  But I digress.

Then there came Southwest with their boarding groups instead of assigned seats.  They seemed to be more of a people’s airline, where everyone was relatively equal.  They also tended to do things that encouraged people to do things that helped everyone else on the plane.  You could get a good seat just by showing up an hour ahead of time at the gate, which helped the plane leave on time since you don’t have everyone waiting for you to saunter onto the plane and find a place for your two oversized bags that you really should have checked.  The other thing they had was much lower prices than the other airlines.  Even their flight attendants and pilots seemed happier.

I remember when I first flew Southwest.  We were going from Tucson to San Jose for a student conference.  A friend was checking on airline fares and I expected something like $500 each.  He said that it was $99, for both of us, both ways!  I was incredulous.  For the next several years one was able to fly all over the country, rarely paying more than a  couple of hundred dollars each way.

Slowly but surely, however, elitism crept into Southwest.  First they eliminated the crowd entry I was so fond of because it meant you didn’t need to stand in line for an hour to get a chance at being near the front of the boarding group.  Instead, they put in the cattle gates where you were in a line with little chance of getting anything but the end of the boarding class unless you were willing to stand in line for a half hour or more.  They then made it worse by assigning actual numbers in the boarding group and then selling out the best numbers in the group for an extra fee so you have no chance of getting on near the front unless you paid an extra fee.  Yes, elitism has arrived at Southwest.  The worse part is they have eliminated the incentive to show up early and be ready to board.  Like the other airlines, you will get the same seat whether you are their an hour early or just show up as they start boarding.

This is not to say that things are any better at the other airlines.  They finally have obtained their lifelong dream of nickel-and-diming their customers for every little thing, from $3.00 for a bag of M&M’s or a soda, to even $25-$100 for checking a bag.  So instead of encouraging people to check their bags, which would make the security lines go faster and make it less likely that the flight would be delayed because people can’t find a place to put their bags once they get on the plane, they are encouraging them to drag everything onboard by penalizing the people nice enough to check their bags and then wait for them another 30 minutes after their flight is in to retrieve them.

If you’re like me, you’ve stopped flying if you are within about 7 or 8 hours of your destination if you drive.  Actually, since I live about an hour and a half away from the airport, it is actually faster for me to drive for those types of trips by the time I drive to the airport (1.5 hours), find parking (15 minutes), take the shuttle (15 minutes), check my bags (15 minutes), go through security (30 minutes), wait at the gate (1.5 hours), fly to the destination (2 hours), collect my bags (1/2 hours), get a rental car (1/2 hour), and drive to the hotel (1/2 hour).  I am also not eager to fly and will drive instead even for longer trips just because of the cost and hassle involved.  It seems just like the bad old days when the airlines really didn’t like their customers and could care less if they pleased them or not.

If you aren’t flying for these reasons, the airlines may eventually see their revenues drop off as more and more of us stop flying.  They could probably sell a lot more tickets if they did a better job with customer service and didn’t gouge their customers, but they probably think all of those fees are a gold mine for them.  When people stop flying, which will happen as they make it less and less pleasant to fly, the airlines will probably think the drop in paying customers is just due to economic conditions or other factors that are beyond their control.  No, the issues that will cause people not to fly are very much within their control.

Maybe if we would call the airlines or write a letter each time we don’t take an airline because of the hassle and fees we told them about it, rather than just not flying, they might start to see the issues and work to correct them.  So, next time you decide to drive instead of fly, drop the airline you would have taken a note and let them know why.  If they get enough notes, maybe things will change.  Then again, maybe they won’t.  Then we’ll just need to wait for the next SouthWest Airlines to come along and disrupt the industry.  Maybe the existing SouthWest will remember its roots as well.

By the way, for about $10 you could get a box of about 20 packs of M&Ms.  Next time you fly US Airways or one of the others charging $3.00 for a bag of M&Ms, think about getting a box and passing them out to your fellow passengers.  For $10 you could cost the airline $600.  Now that’s leverage.

Contact me at VTSIoriginal@yahoo.com or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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