[Ed Note: You can now download the entire ‘How to Buy and Sell Shares’ six-part series for FREE. To download your copy right now go here.]
This week we’ll look at something different – Exchange Traded Funds, or ETFs.
On any given day in the US stock market two stocks are typically traded more than any other. It isn’t the stock of Coca-Cola [NYSE: KO] or General Electric [NYSE: GE]. And it isn’t Apple [NASDAQ: AAPL] or Ford Motor Company [NYSE: F].
No. Among the most traded stocks each day, you’ll find the SPDR S&P 500 ETF [NYSE: SPY], and the PowerShares QQQ Trust ETF [NASDAQ: QQQQ].
Both of these are exchange traded funds. You can see on the table below just how active these stocks are:
Click here to enlarge
Source: Google Finance
In fact, four of the top ten most active stocks traded in the US on Thursday were ETFs.
The US is the home of the ETF. There are hundreds of them covering broad market indices such as the S&P 500 and Russell 2000, through to sector specific indices such as the financial, pharmaceutical and biotechnology sectors.
The good news is the Australian stock market has a number of ETFs listed too. Although it should be noted the volume of trading in these ETFs is nowhere near the volumes you get in US ETFs.
To show you what I mean, you can see in the above table that 176.45 million shares of the SPDR S&P 500 ETF were traded on Thursday. At the current share price of USD$133, that’s over USD$23 billion of stock changing hands – and for just one ETF.
In contrast, the average volume for the most popular Australian ETF – the SPDR S&P/ASX 200 Fund [ASX: STW] – is less than 200,000 shares per day for a value of just $9 million.
The beauty of ETFs is they trade just like a share. So you can buy and sell an exposure to a broad range of stocks by buying and selling a single stock.
This can be cost effective if you’re only interested in buying the main shares in the index, such as banks, the big resources companies and the big retailers.
It means you don’t have to buy shares in individual blue-chips such as BHP Billiton, Rio Tinto, ANZ Bank or David Jones. You can just buy shares in the ASX 200 ETF and get an instant exposure to all those stocks and many more…
The downside is that you’ll never get a return better than the return of the index. That’s the problem with diversification. And actually, I don’t believe in portfolio diversification.
I know that may sound odd as it’s the one thing most financial advisors recommend. But the fact is diversification only serves to lower your returns. In my view, I believe you’re better off putting in the effort – either yourself, or paying someone to do it for you – and investing in a limited number of stocks.
If you get it right then your returns should be better than the index – and that means better than most other investors. Of course, if you get it wrong then you’ll do worse. But that’s why it’s important to be an active investor, closely monitoring your investments.
But, if you don’t have the time or inclination to be an active investor, using ETFs is fine… it’s certainly better than doing nothing!
Anyway, even though the Australian ETF market isn’t as developed as the US market, there are still a number of different ETFs to choose from. So if you want to diversify your portfolio or get an exposure to different markets then you can.
Below is a list of the ETFs I believe could be of most interest to you, although there are a few others too:
- SPDR S&P/ASX 200 Fund [ASX: STW] – includes the top 200 Aussie stocks
- Betashares S&P/ASX 200 Resources Sector [ASX: QRE] – includes resources stocks from the top 200 Aussie stocks
- SPDR S&P/ASX 200 Listed Property Fund [ASX: SLF] – includes listed property stocks from the top 200 Aussie stocks
- Vanguard US Total Market Shares Index [ASX: VTS] – includes 99.5% of the stocks listed on the US market
Another that I thought was interesting is the Betashares US Dollar ETF [ASX: USD].
In a nutshell, this ETF lets you punt on the value of the US dollar against the Aussie dollar.
If you think the US dollar will rise then you buy this ETF. If you think the US dollar will fall then you should short sell it (by the way, I’ll explain short selling next week).
ETFs can serve another purpose. If you’re new to the stock market buying an ETF can be a good way to cut your teeth on the market, because you buy them just as you’d buy any other share.
It can be good practice to buy, hold and sell, knowing that even if the worst happens in the short term, you won’t lose all your money – although ETFs do follow the index, so they can go down a long way in a bear market. Remember the main Aussie index fell 50% from late 2007 to early 2009.
But once you become more confident and gain a better understanding of how the shares game works then you can try your hand at a few individual stocks.
As I say, ETFs aren’t always the best way to invest, but they are an acceptable in certain circumstances. For instance, I’ve recommended a number of ETFs to subscribers of my investment advisory, Tactical Wealth. I can’t tell you which ones, as that’s for paid subscribers only
Of course, I can’t tell you which one it was as that’s only for paid subscribers. But Dan was looking to give his readers a specific type of exposure to the market, and figured an ETF was the best way to do it.
The upshot is, if you’re an experienced investor Australian ETFs will be of limited use to you. Although if you’ve access to a US trading account you could check out some of the many ETFs available there.
If you’re a new investor I still believe individual stocks are the best way to go. But if you’d like to take things a small step at a time then looking at one of the ETFs I’ve mentioned above could be a good place to start
For Money Morning Australia
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