How to Pick an ETF and 3 Best ETFs Every Investor Should Buy
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How to Find the Best ETF to Buy for Your Portfolio
There is an easier way to invest that takes the stress out of picking stocks and it can actually help you get higher returns.
In this video, I’ll show you how investing in ETFs takes the stress out of investing and helps you make more on your portfolio. You’ll see how to pick the best ETF and then I’ll reveal three exchange traded funds every investor needs to buy.
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A Simple Guide to ETF Investing
Now everyone here in the Nation, you know I like to make investing as easy and as stress-free as possible. You’ve got enough to worry about, I want to give you the tools to put your money to work without worrying if it’s going to be there when you need it.
And one of the best ways to do that is through ETF investing, investing part of your money in exchange traded funds for a set-it and forget-it strategy that besides giving you a stress-free way to invest can actually help you pick better stocks to buy as well.
So I wanted to make this video an all-in-one guide for investing in ETFs. We’ll start with the basics of ETFs explained, show you how they’re different from mutual funds. I’ll share the pros and cons of ETFs and why every investor needs to be using this strategy. Finally, I’m going to show you how to pick an ETF and reveal the three exchange traded funds every investor should own.
What is an ETF?
An ETF or exchange traded fund is just a group of stocks or investments held by an investment manager according to a theme or sector. The manager or investment company then sells shares of the fund so investors can get a fractional ownership of all the stocks held.
I’ve seen ETFs with as few as a couple dozen stocks and some with as many as a few thousand stocks or bonds. For example, the SPDR S&P 500 ETF, ticker SPY, holds all the stocks in the S&P 500 index, the largest companies based in the United States. Buying a share of the fund means you get a piece of every stock in the index; shares of Apple, Microsoft, Amazon and Johnson & Johnson and a return that follows the broader market exactly.
ETFs versus Mutual Funds
ETFs are similar to mutual funds but like an evolutionary step in investing. When mutual funds came out in the 60s, they went a long way to open investing up to everyone but had a lot of disadvantages.
ETFs were created to answer these weaknesses. Compared to a mutual fund, exchange traded funds are less expensive, the average fee you pay each year to the investment manager is a fifth of what you’d pay for a similar mutual fund. ETFs are faster to buy and sell, they trade just like stocks and can be bought in seconds versus a mutual fund where you have to wait to the end of the day to get a price. ETFs cost you less in taxes as well. You only pay taxes on an ETF when you sell or get a dividend but you might have to pay taxes on a mutual fund every year, even if you keep investing in the shares.
Besides just the benefits over mutual funds, ETF investing gives you an investment in an entire asset, theme or sector without having to pick stocks.
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Should I Invest in ETFs?
This is that broad, macro-level investing that I love. Finding those universal forces and investing in the themes or groups that will benefit. For example, as interest rates start to fall, maybe you want to invest in the telecom sector because lower rates means a more attractive dividend yield for the stocks in the sector. But instead of sifting through financial reports all day long to find the best companies, you can just invest in the Utilities Select Sector SPDR, ticker XLU, which holds all 28 utility companies in the S&P 500.
ETF investing is also a great way to get a stress-free, low-cost investing strategy, something you can set up and never have to worry about. In fact, later in the video, I’ll show you three funds that could be your entire investment portfolio – just three ETFs to buy to make your money work for you.
How to Invest in ETFs
My favorite way to use ETFs though is as part of a core-satellite approach. This is where you invest most of your money, between fifty- to seventy-percent, into a group of three to five ETFs that give you broad exposure to assets and the market. That core portion of your portfolio gives you a diversified selection of stocks, bonds and real estate.
You then take the rest of your money and invest it in a small handful of individual stocks, maybe 8 to 12 stocks at the most.
And this ETF strategy works on a couple of different levels. First, you get that broad investment through the funds. You get investments in all the asset classes and themes. These are diversified, less risky because they’re spread across hundreds of stocks, so you really don’t have to worry about this money. It’s going to churn out a market return every year.
But it also gives you the opportunity to make a higher return on that small group of individual stocks. Because you’re limited to how many stocks you buy, you’re only focusing on the very best companies. You’re not spending hours analyzing stocks every week because you’ve got your favorites and don’t need to chase every hot stock you hear about.
Downsides to ETF Investing
But you know what we say here in the Nation, it ain’t all rainbows and unicorns either. There are some downsides to investing in ETFs.
One risk is that you have your money spread across too many stocks in the funds that you aren’t getting more than the market return. You’re basically too diversified with too little in individual stocks to make a difference.
This is why I like that core-satellite approach because you can use the thirty-percent or so of your money to boost your returns through those individual stocks.
Another drawback is the expense ratio you pay to invest in these funds. Now I’m going to show you three funds with annual fees so low they’re basically nothing but some funds can be really expensive to hold.
These are usually special themes like investing in alternative investment funds or ones where the manager has to actively trade the stocks nearly every day. While the best ETFs will charge an expense ratio less than half a percent, you see here some ETFs charge as much as three percent and higher to hold the fund.
One more drawback here and I’ll show you how to pick an ETF, but some of these can get overly complicated and involve more risk than investors understand. There are ETFs that use options and futures derivatives to leverage returns, usually called an Ultra-Fund, two- or three-x. Then there’s closed-end funds that use leverage and aren’t traded like ordinary ETFs, both of these types are usually extremely expensive and not good for that long-term investing strategy.
How to Analyze ETF Investments
Let’s look at how to analyze an ETF then I’ll show you those three best ETFs to start your portfolio.
Going to the website for any ETF, you’ll see fund-level analysis of all the stocks including a PE ratio, number of holdings and returns over different periods.
Because most funds hold dozens or even hundreds of stocks, the analysis you’re going to do is really on that bird’s-eye, macro-level on the theme or the group. For example, that SPY fund tracking stocks in the S&P 500 holds over 500 stocks with even the largest weighting, shares of Apple, only accounting for about 6% of the fund.
So the effect on returns from any one stock isn’t going to add up to much and you really don’t need to analyze individual stocks here. Instead, you’re looking at how the bigger picture economic forces are going to be driving the entire group. How will those forces affect stocks in the sector or the theme?
That’s going to be a big factor in how you pick an ETF to buy.
How to Pick an ETF
When you start out looking for ETFs to buy; you’re either looking to fill gaps in your existing portfolio or you’re looking for the investing themes that might do well.
So maybe you notice you don’t have any bonds or real estate in your investments or you have all tech stocks so maybe you want to diversify into other stock sectors. Because of course, if your portfolio is so concentrated into one sector or one asset class, you run the risk of missing your goals when the market turns against that one group. We’re talking about creating a diversified portfolio around the three major asset classes and around the sectors or groups within each.
Or like we talked about, maybe you see something in the broader economy that makes you think one particular investing theme will do really well. For example, when the lockdowns started, I was looking at the stocks that would benefit like connectivity and those in the remote work space. Now I could have searched through thousands of stocks to find those that could do well, or I could invest in a group through an ETF, something like this Global X Cloud Computing ETF, ticker CLOU, that has outperformed the market by 45% over the last year.
Once you’ve found that theme or the ETF idea you want to invest in, then you need to pick an individual fund from those available. For example, a quick Google search for cloud computing ETFs shows me four funds in the theme.
And there’s three things you want to look at when picking an ETF; the expense ratio, dividend yields and returns and the fund portfolio.
The expense ratio is probably the most important. The returns on most funds in a specific theme are going to be pretty close. They all follow stocks in the same group so you’d expect them to be relatively similar in terms of return…but how much of that return you keep is going to depend on how much the fund charges.
For example, going back to our four cloud computing funds, there’s a quarter of a percent difference between the funds with the highest fee and the lowest. That might not seem like much but it’s $250 a year on a hundred-thousand dollar portfolio and it’s going to add up over the years.
You out there in the Nation know, we’re all about dividends here on the channel so I’ll usually look at the dividend yield and total return on funds as well. Of course, you don’t want to sacrifice all the price return for a dividend, so I like to look for funds that are paying out a decent dividend but also able to grow the share price.
Finally here, I’ll just compare the portfolios of the different funds. The website for any fund will show you the portfolio holdings along with what percentage of the fund is in each stock, sector or even by geography.
Here I’m looking for ETFs that aren’t too heavily weighted in any one stock. You know, if I just wanted one stock to be a large part of my portfolio then I’d just buy that stock. The idea here is to get that broader exposure to the investing theme or sector through each stock in the group.
Best ETFs to Buy for Your Portfolio
Now you’ve got everything you need to pick the best ETF but I want to get you started with three of my favorite. These three funds will give you broad exposure to the three major asset classes; stocks, bonds and real estate, at a low-cost and produce higher cash flow than other funds.
Our first ETF is a great dividend stock fund, the SPDR Portfolio S&P 500 High Dividend ETF, ticker SPYD.
The fund is designed to invest in the top 80 dividend-yielding companies within the S&P 500 companies, so these are the highest yielding stocks among the largest U.S.-based companies.
Here you see the sector breakdown, pretty heavily weighted to financials, real estate, energy and utilities, which shouldn’t come as a surprise since these are the sectors that typically pay higher dividends because of those stable cash flows.
Against that heavy exposure to a few sectors, the ETF is actually well diversified across individual stocks with no company more than 1.5% of the assets. What I really like about this fund though is its dividend yield and expense ratio.
The SPYD pays a 6.1% dividend, about three-times the average yield on that broader S&P 500 index, and charges just 0.07% annually. That means you’re paying just $0.70 for every thousand-dollars invested to own this high yield fund.
So definitely reasons to consider this one. High dividend yield and exposure to the upside in stocks at an expense ratio that’s basically negligible. As we say here in the Nation though, it ain’t all rainbows and unicorns. The downside is the weighting to those sectors. With 42% of the fund in stocks of financials and real estate, then another 22% in energy and utilities; you’re at the mercy for whatever happens in those four sectors.
And with that weakness in financials and energy over the last year, that means the fund has underperformed the stock market by about 35%…could also mean though it bounces back for some healthy price gains if those two sectors can stage a rebound.
Next is an ETF favorite of mine, the Vanguard Real Estate ETF, ticker VNQ, and its 4% dividend yield.
Those of you in the Nation know, I’m a big believer in real estate. It’s where I got my start as a commercial real estate analyst and with rental property and there is no other asset class that has created as much generational wealth.
The Vanguard ETF invests in 181 individual real estate investment trusts, that’s companies that own commercial real estate in every property type and throughout the country. And it’s well diversified across those property types; office, retail, industrial, healthcare, residential and companies that own several types.
So not only does real estate produce a solid cash return, paid in that 4% dividend yield for the fund, but it’s a good diversifier from that risk in stocks for your portfolio as well. Real estate values aren’t tied to the same economics as stocks so you don’t get both crashing at the same time.
The fund has produced a 9.7% annual return over the last decade though it has fallen about 7% in the last year. Besides the tourism-related and retail sector REITs taking it this year, the office property market is struggling under that work-from-home momentum.
Still though, the property market is still fairly strong and there could be some good value in a few of these property types waiting to boost the shares higher. The expense ratio of just 0.12% is extremely low and you get that 4% dividend yield while you invest.
With this next ETF, the SPDR Bloomberg High Yield Bond ETF, ticker JNK, we’ve got exposure to all three major asset classes.
So we got exposure to stocks with the dividend fund and real estate with the VNQ. Here we get exposure to the third asset class, fixed income or bond investments.
And actually these non-investment grade bonds are something of a mix between the safety of bonds and the upside of stocks. You see, when a company issues debt, the bonds get rated according to different financial risks. The really strong companies get what’s called an investment-grade rating; triple-B or higher, while the riskier bonds get a non-investment grade or junk rating.
The truth is that even the lower-rated bonds have very low defaults, averaging less than 5%, and pay much higher interest rates so can actually provide a solid return along with much less risk compared to stocks.
You see the sector exposures here with the fund diversified across bond of consumer goods companies, communications, energy and 11 other groups.
And I like this fund versus maybe some of the other bond funds because investment grade funds like the BLV or BSV, that’s two other Vanguard bond funds, have had really strong years. Here you see the three funds; the JNK in green with a 5% loss against a 3% gain on the BSV and a 10% return on the Vanguard Long-Term Bond Fund, the BLV.
Nation, a 10% return on investment-grade bonds is insane! Interest rates have sunk so fast that investors rushed into those bond funds and there just isn’t much value left. That high-yield bond fund though, the JNK, because the companies are more susceptible to a recession, hasn’t performed as well and I think there’s more upside along with the dividend.
So with this one, you get a 5.8% yield and a fairly low 0.4% expense ratio. The one downside I want to point out here is what we just talked about. Because these companies are riskier in terms of finances, the fund will underperform during a recession but will give you a better upside as the economy improves.
ETF investing is a critical part of your overall investing strategy. It can help you not only reduce the stress around your portfolio but help free up time to make sure you're finding the best individual stocks. Learn how to find the best ETFs to buy and how to pick these fund investments.
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