Investing With ETFs – Part 2

In last week’s article, I talked about the benefits of investing in ETFs. This week I provide readers with more tips about ETF selection and investments.

5 Things To Look For When Buying ETFs

Exchange-Traded Funds are simple to understand. Below are five key factors that you should consider when choosing ETFs:

  1. Providers/Sponsors – Who is sponsoring the fund? These days the ETF industry is concentrated in a few big names. The scale and reputation of these providers should promote long-term stability. However, there are many smaller (niche) providers that are equally good. In the UK, iShares (Blackrock) and Vanguard are two trusted ETF providers.
  2. Underlying (Benchmark) Index – Find out what is the ETF try to achieve. Most ETFs will have an underlying index to track, which may or may be maintained by the ETF provider. Take the iShares FTSE 100 ETF as an example. The underlying index is the FTSE 100 Index, which is calculated by the FTSE Group. This index is then licensed to iShares, which attempts to replicate the returns of the FTSE 100 Index. Some indices could be esoteric and difficult to understand. They should be avoided. Also, if the underlying assets have illiquidity problems, this will result in large tracking errors. Additional questions you should ask:
    1. Equity ETF: Large-, mid- or small-cap? Single country or regional?
    2. Bond ETF: Gov or Corporate bonds? High-Yield (junk) or Investment Grade?
    3. Commodity ETF: Single or multi-sectors? Stocks or futures or synthetic? Roll Yield?
    4. Other questions: Is the ETF priced in domestic or foreign currency? Currency hedged? Where is the fund domiciled? Can it be traded within ISA or SIPP?
  3. Cost – Every fund costs money to run. Management fee, custody, and compliance costs could be considerable. Some ETF providers are more efficient, therefore provide cheaper funds for investors. The thing to look is the Total Expense Ratio (TER), which is the percentage of fund assets used to cover the fund costs annually. This figure will be published by provider for each fund. Avoid funds with high TERs.
  4. Size – Given the large range of ETFs in the market, investors naturally gravitate towards those ETFs that are better known, more efficient, and least costly. Choose larger ETFs as their liquidity/trading volumes are better. Remember that the asset class behind the ETF may also impact the bid-ask spread.
  5. Income – Does the ETF pay any income? Not all does, such as physical commodity ETFs. For many, dividends are paid on a periodic basis (quarterly or semi-annual). Find out more from the ETF’s fact sheet.

As a starting point, I list the Top 20 ETFs below for readers. They all trade on the LSE.

Once you have narrow down a list of ETFs, the next question is: How do you invest in ETFs?

Three Ways to Invest in ETFs

There are many ways to ‘skin a cat’, so to speak. For ETFs, the three investment methods are:

  1. Buy-and-Hold. This method is for investors who aim at long-term income and capital appreciation. This is suited for income-seeking, long-term portfolio builders, and investors that eschew market timing.
  2. Buy-and-Hold with some market timing. For example, you could use the the so-called Ivy Portfolio strategy developed by Mebane Faber to protect your portfolio during bear markets. For instance, the method requires a monthly update on your portfolio holdings to see if the ETF has traded below its 12-month moving average. If it does, sell. An example of this method is given below.
  3. Market Timing. This mean you will trade and churn your ETF portfolio depending on your views and trading methods. Transaction costs will go up if the churn is excessive.

Another point to remember is the weighting of each ETF in your portfolio. You may put more capital into bond ETFs as they are less volatile than equity ETFs.

In conclusion, which method is for you? I can’t tell you this as the answer is inside you already. You just have to find it. In searching for the ‘perfect method’, however, it pays to remember John Bogle’s advice:

Long-term investment success is based on simplicity.*

*John Bogle was the founder of the Vanguard Group. He passed away earlier this month.

List of Top 20 UK ETFs

  1. iShares FTSE 100 (2000) – ISF
  2. Vanguard FTSE 100 (2012) – VUKE
  3. SPDR FTSE All Share (2012) – FTAL
  4. Vanguard FTSE 250 (2014) – VMID
  5. iShares UK Small Cap (2009) – CUKS
  6. iShares UK Dividends (2005) – IUKD
  7. Vanguard FTSE All World Equity (2012) – VWRL
  8. Vanguard FTSE All World Dividend (2013) – VHYL
  9. Vanguard S&P 500 (2012) – VUSA
  10. Invesco Nasdaq 100 (2002) – EQQQ
  11. iShares Core MSCI Europe (2007) – ISEU
  12. xTrackers Stoxx 50 (2008) – XESC
  13. Vanguard FTSE EM (2012) – VFEM
  14. iShares Core UK Gilt (2006) – IGLT
  15. SPDR Bloomberg Barclays 1-5 Year Gilt (2012) – GLTS
  16. iShares Sterling Index-Linked Gilts (2006) – INXG
  17. iShares Corporate £ Bond (2004) – SLXX
  18. Invest Physical Gold (2009) – SGLD
  19. ETFS Physical Silver (2007) – PHAG
  20. iShares UK Property (2007) – IUKP

Where can you trade and invest in ETFs?

Here is a quick guide to some of the best UK brokers that offer access to ETFs for trading or investing:

Or you can compare our selection of the best ETF brokers here…

Good Broker Guide Featured Brokers

Looking for institutional broker? Compare prime brokers here

Jackson has over 10 years experience as a financial analyst. Previously a director of Stockcube Research as head of Investors Intelligence providing market timing advice and research to some of the world largest institutions and hedge funds.

Expertise: Global macroeconomic investment strategy, statistical backtesting, asset allocation, and cross-asset research.

Jackson has a PhD in Finance from Durham University.