6 things to look at before buying an ETF
This will be to no surprise for any regular readers but we at IntelligentSpeculator are fans of ETF’s, they provide such an easy and transparent to trade the markets. There are of course many reasons to use them but generally, I think they are the most appropriate investments for smaller portfolios. Let’s be honest, ETF’s are the easiest way to have a diversified portfolio that can be re-allocated easily.
Of course, when you have a few million dollars, the fees charged by most ETF’s are a bit expensive. But most of us, unfortunately, do not have millions to invest. So between mutual funds and ETF’s, the choice is very easy. But with that being said, now more than ever, new ETF’s are born every week it seems and they might not be all that great to invest in.
Here are a few criteria’s we believe to be important when looking for a suitable or acceptable ETF:
1-Annual fees
This might be the most obvious point, but it is not as straightforward as you might think. Actually, while ETF’s do generally have very low annual fees, not all of them do. It is important to look at them when considering buying ETF’s for a long term investment. It is difficult to give a number to look for as it really depends on the type of ETF. Generally, ETF’s that invest in US equity markets should have very low fees, of .50% or so. But ETF’s that invest in emerging countries will and should have higher fees. After all, the managers will face higher trading, execution and even legal fees. That is one of the costs of business when dealing in emerging or frontier markets.
2-Liquidity
This is one of the most underestimated criteria’s. While there are new ETF’s every day, some of them have so little liquidity that you will be paying enormous “fees” in bid-ask spreads. Basically, imagine a stock that is worth 10,50$ but you must pay 11$ to buy it and once you sell it, you will get 10$. That would imply a 1$ spread (10$ bid, 11$ ask). You would lose 1$ (almost 10%) on the trade even though you actually made an investment that did not lose any value. Crazy isn’t it? I think it is one of the biggest mistakes made by investors when choosing an ETF.
There are generally two things to look at when considering the liquidity. First off, you want enough size to be available. As a rule of thumb, I like to trade no more than .1% or 1% of the average daily volume. Because if you try to buy a 1000 units of a stock that generally as 10,000 traded, you will have an effect on the price and will end up paying higher.
At the same time, a good way of looking for liquidity is to look at any time during the day at the bid and ask on the ETF. Generally, a very liquid ETF will have a bid -ask close to 0.01$… So a bid 10.49, ask 10,50. It can get a little worse than that but I personally do not really consider stocks that trade at a bid-ask of more than 0,10$, it is simply too illiquid and risky.
3-Underlyings
Generally, you can easily find out what is owned by an ETF and take a look. You will get an idea of what it does etc. It could turn out that you are easily able to replicate the ETF and could end up paying fewer fees. For example, I had written about target date funds that basically give you a one stop option investment possibility. I had considered investing in it but then noticed it only had about 7 or 8 underlings’. In such a case, especially for a 30 year investment, I will be better off investing in those 7-8 funds myself instead of paying the additional fee to the target date fund manager.
4-Company behind the ETF
Like any other investment, it is worth taking the time to look into the company that is managing the ETF. Is it reliable, profitable? Those are all good questions. I personally like Ishares a lot because they are so huge, have a good reputation and while they have recently been sold, they are still owned by a very reputable company in Blackrock, now the largest fund manager in the world. Picking smaller lesser known companies might give you a slightly better chance of investing in a fraud like those we’ve recently witnessed, unfortunately.
5-Prospectus
Depending on the fund, it can be a good idea to take a look at the prospectus of an ETF. While an ETF that tracks the S&P500 is fairly straight forward, others such as leveraged ETF’s and/or those investing in commodities are subject to many other criteria’s that you might not know before investing. For example, knowing if a fund invests in physical natural gas or in companies that produce the physical gas makes a huge difference and yet many confuse the two.
6-Past performance (vs. index)
It is always good to compare the return of the ETF in the past year or more to the return of what it is tracking. If the S&P500 is up 10% for the year and your ETF is only up 2% or is up 18%, you should investigate. Of course over performing is good, but you have to wonder what caused this as it could result in an underperformance the next time around.
So those are the basic things we personally look at when trying to evaluate an ETF, what about you?
This week was another down week for Natural Gas as it merely escaped slipping undr the psychological 3$ level. How much lower can it go? Without further wait, here are some of the better posts/articles that I read this week:)
Since it was created (probably many many centuries ago), marketing has always been about getting attention, getting a message or an idea across and more often than not, it is just about getting its name out there. In the Airline industry, that is always quite a challenge as most consumers have only one criteria when shopping for airfares; price. And while JetBlue has been more than competitive, there has and always will be a lot of value in having a brand associated with pleasure, good service, etc. Because that means that consumers will probably choose your company if they are offered the same fare for a trip. And even better, they might even accept to pay a little more to board your airline at some point.
Remember those days when the RIAA was complaining about customers no longer buying music? Well, turns out they are although the model has changed. And so has the power as it has shifted towards Apple. Thanks to this nice graph from 
A lot of interesting things going on in the markets but the collapse in prices of Natural Gas (it just hit a 7 year low even as oil prices continue to go higher, a trend few believed possible even a few months ago, and yet it keeps going and going, as well as the hype surrounding the problems of ETF fund UNG are at the top in my opinion. With that being said, here are the most interesting readings I enjoyed last week:
See reactions here
What would you do if you could have a business model with almost no risk, a 70% profit margin at worst and no innovation or research to work on? That is pretty much what the lotter business enjoys. Even though they make the headlines when they offer prizes that can often reach hundreds of millions of dollars, the fact is that they have the best odds of all. For each ticket of one dollar, they might give you a 1/50,000,000 shot at winning $5M.. that is a 90% profit margin. Sure, you might be unlucky and have a few lucky players. But since it is possible to get insurance on all gains, you really have nothing to lose now do you?
In 2009, the world is seen by many as smaller than ever, or “flatter than ever”. That is certainly true of finance as capital flows around the world. However, countries have very different levels of structure which can result in different degrees of complexity in their capital markets. In geographical terms, the investments are usually classified as following:
The spectacular rise in North American markets in 2009 has created the fear of a rellapse as many think the market might be overly positive. This weekend was a good example of why. Japan, the world’s #2 economy, is out of a recession with an impressive 3.7% expansion in the last quarter. But if you think the markets have been impressed, I can tell you right now that you are wrong, very wrong. JP Morgan senior economist Masamichi Adachi said “the basic contours of the growth is what we had expected: Consumption, exports and public works all contributed to the positive side.”
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