Exchange-traded funds (ETFs) are a basket of investments that attempt to mimic a particular index or investment. Investors buy shares of the ETF to capture substantially similar investment performance. They are similar to index funds in that respect; however, ETFs trade throughout the day, often have lower fees, and you can short them as well as trade them on margin.
Evaluating ETFs is similar to mutual funds. You can get information on them from Morningstar.com, Yahoo Finance or the fund company’s website, for example, iShares.com or StateStreetSpdrs.com. The fund company websites should have tear sheets on each ETF that provide a list of holdings and the discounts or premium the shares trade. ETFs do not always trade at what the underlying investments are worth, because of their use of futures and options. ETFs have to use these to minimize the tracking error, so they stay in line with the index they are mimicking.
ETFs are a good way to gain exposure in areas where an investor does not want to buy single stocks. For example, we discussed both oil service and housing stocks during last week’s broadcast of “Money Talks.” Rather than try to assemble a portfolio of oil service stocks, an investor may opt for an Oil Services and Equipment ETF that provides exposure to a wide range of companies. Perhaps, as an investor, you feel that housing will recover soon. A housing ETF should provide exposure to basic materials companies that sell building materials, in addition to home builders and retail stores like Home Depot (NYSE: HD) or Lowe’s Companies (NYSE: LOW). ETFs can also be a good way to fine-tune a portfolio, increasing a smaller sector without having to purchase individual stocks.
Investors may wonder if exchange-traded funds will replace the need for mutual funds or money managers who invest in individual stocks. First, we believe that portfolio managers will still be useful, as most ETFs are unmanaged. There may also be several different ETFs that track an index or sector. Investors should still need to know which ETFs to own and which ones to overweight.
Secondly, mutual funds are managed by portfolio managers. Some portfolio managers have long-term performance of beating their benchmarks. This opportunity for increased return will likely always have a market.
Thirdly, we believe investors will still require the financial planning aspect to provide a mix of stocks and bonds in their portfolios. We highly recommend avoiding target-date funds, as they have not produced in recent years. In the current low-interest rate environment, bond funds have not been able to provide the yield investors are seeking, which is why we believe investors would be better served owning a diversified portfolio of dividend paying stocks rather than target-date funds.
At Henssler Financial we believe you should Live Ready, which includes understanding how ETFs may fit into your portfolio before purchasing them. If you have questions regarding the mix of investments in your portfolio, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.