Investors are joining the passive investing revolution in droves. Fed up with paying high fees to invest in stocks and mutual funds, they are merrily dethroning actively managed funds. The champion of this revolution is the low cost exchange traded fund (ETF). Because ETFs track an index of stocks or other investments, they do not incur the high costs of buying and selling individual investments.
What are ETFs?
An exchange-traded fund (ETF) is a basket of securities chosen to replicate an underlying index. They can be diversified across one type of security or many (stocks, bonds, commodities etc.). Like mutual funds, ETFs are a pooled investment fund that sell shares in a portfolio of investments. Different from mutual funds, ETFs can be traded intraday like stocks.
Why Invest in ETFs?
When you buy ETFs, you do not have to accept the end-of-day price offered by mutual funds. ETFs are funds with the characteristics of stocks, including:
- Real-time trading
- High liquidity
- Long, short and arbitrage positions
- Limit and stop-loss orders
- Fractional trading
- Trading on margin using leverage
But different from stocks and mutual funds, ETFs offer:
- Lower fees
- More tax advantages
How to Invest in ETFs
This year, investment in passive equity funds, led by ETFs, will surpass actively managed funds. ETF investing has grown alongside the rise of the robo-advisors. With the convenience of mobile trading, they are now the most actively traded security. If you are not yet part of the ETF investing movement, investing in ETFs is as easy as ordering an Uber taxi. Investors buy ETFs while standing in line at the post office, riding the subway or listening to the opening movement at the symphony.
With an indisputable place in most any diversified investment portfolio, ETF assets have swelled to over $5 trillion. ETFs are sold by online brokers, banks, large mutual fund suppliers, and robo-advisors. Online brokers provide one or all of the following ETF investment options.
🔳 Buy and sell ETFs directly like stocks
🔳 Invest in portfolios of ETFs
🔳 Set up an automated program to invest a specified amount at regular intervals in ETFs
🔳 Automatically buy and sell ETFs to rebalance a portfolio
How to Choose an ETF Broker?
While shopping for an online ETF broker, evaluate:
Number of ETFs – A large number of diversified ETFs makes it easier to develop a diversified portfolio. More importantly, the ETFs should be from reputable suppliers and have good liquidity.
Credit quality – ETFs are rated like stocks based on their creditworthiness. Morningstar is a reputable assessor of ETFs and mutual funds. The highest rate Morningstar ETFs have low fees and are broadly diversified.
Benchmark alignment – The ETF should closely replicate the index it tracks. When the index component changes, the ETF should be adjusted accordingly.
Costs – In addition to the ETF expense ratio, brokerage commissions will add to your costs.
Tax implications – If an index does a lot of trading or invests in certain commodities, taxes may be higher. Read the fine print in the ETF prospectus.
Best UK ETF Broker for 2019 – eToro:
- What is eToro?
- Buy an ETF on eToro
- Invest in ETFs With CopyTrader™
- Invest in ETFs With CopyPortfolios™
- Why Buy ETFs on eToro?
Fees: 0.00 pa
Min Deposit: $200
eToro offers direct stock and ETF trading, as well as CFDs on over 2,000 securities. eToro’s universe of over 60 ETFs may not be the largest but where the leading social trader excels is in providing many ways to invest in top performing portfolios with ETFs. On eToro, you can copy a winning trade or entire portfolio of a peer in one click with its popular CopyTrader™️ and CopyPortfolios™️ tools. Traders can use up to 5x leverage on margin accounts. eToro does not charge trading fees. Withdrawal fees are $25. An inactivity fee of $10 a month will be charged after 12 months of inactivity.
To choose an ETF, select an ETF from the markets page. Research the ETF by clicking on: Social Feeds, Statistics, Chart, and Research. If you are ready to invest, click Trade. The trade order box will pop up. The order process is identical to placing a stock order.
Select Market (current price) or other price level you want to enter the market at.
Enter the amount you want to trade.
Indicate the amount of leverage you want to apply (X1, X2, X5).
The Stop Loss and Take Profit levels can be preset by you.
You can also set up a One Click Trade option and preset the above parameters.
With CopyTrader™, you can copy the top performing trades and portfolios of your peers. To find a portfolio to copy with ETFs, start with the Top Performing and Editor’s Choice portfolios. Choose from the selection of copy traders by reviewing their risk score, trading performance stats, charts, and portfolio. In this example, Spxhedgefund has added two ETFs to a diversified stock portfolio to produce two very different outcomes – hedging and speculating. iShares TLT, a basket of 20-year treasury bonds whose prices move in the opposite direction of stocks, is a good hedge against stock price declines. The iShares VXXB ETF, in contrast, is highly correlated with the broad S&P 500 stock index over the short term, but very volatile. It tracks the CBOE Volatility Index (VXX), which tracks short-term futures on S&P 500 index options.
Click Copy. From the copy trade box, choose the amount you want to trade and the copy trade stop limit. Press Copy.
Choose a portfolio among dozens of investment themes. CopyPortfolios™ copies multiple portfolios and traders following that theme. The GlobalETF portfolio includes six ETFS tracking country stock indices.
The largest holding the iShares EFA ETF tracks companies in Europe, Australia, Asia and the Far East (EAFE).
Review the portfolio’s risk profile and performance. Click on Invest. From the Invest box, choose the amount you want to invest and the stop investing limit.
- How to Buy ETFs on M1 FinanceThere are three ways to invest in ETFs on M1.
- OneClick to copy trades and entire portfolios
- No commissions or fees
- Competitive spreads
- Licensed by multiple jurisdictions, including the UK’s Financial Conduct Authority (FCA)
- How to Buy ETFs on M1 FinanceThere are three ways to invest in ETFs on M1.
Best US ETF Broker for 2019 – M1Finance
Fees: 0.00 pa
Min Deposit: $100
M1 Finance is an ETF supermarket with over 2,000+ exchange traded funds to choose from. Over 4,000 stocks traded on the NYSE, NASDAQ, and BATs are also available. Create your own custom Pie of up to 100 ETFs and stocks (called slices). There are no fees or limits on how many pies you can include in your portfolio. ETF expense fees apply. Once you have chosen your portfolio allocation, this robo-advisor automatically buys and sells your holdings to maintain your ideal portfolio balance. Low cost margin borrowing at 4 percent allows you to trade ETFs with leverage. The M1 Spend checking account with debit card sweeps excess cash into investments.
There are three ways to buy ETFs in M1 Finance – Direct Investing, Expert Pies, Portfolio Rebalancing.
2. Choose the Funds tab to display the more than 2,000 ETFs available.
3. Click on the fund you want to invest in.
4. Review the ETF performance and expense fees.
5. Click on Add to Pie to buy the ETF.
6. State the percentage of your portfolio you want this ETF to represent.
7. Save the new portfolio.
2. Choose an investment objective (Plan for Retirement, Responsible Investing, Income Earners, Hedge Fund Followers etc.) or theme (Industry sector).
3. Choose your investment style, from Ultra Conservative to Ultra Aggressive.
4. M1 Finance will recommend a customized portfolio of ETFs.The more conservative portfolios will have a larger slice invested in bond ETFs.
2. Select Confirm. M1 will automatically increase the weight of underweight allocations and decrease overweight ones.
- No fees or commissions
- Free automated portfolio rebalancing
- Sweeping of cash into higher earning investment accounts
- Tax efficient allocation strategy
What to look for in ETFs?
Some brokers work exclusively with one ETF provider. The ETF selection may be limited and costs higher, but not in all cases. iShares for example, a popular supplier, is among the cheapest ETF providers.
2. Bid-ask Spread
The spread is the difference between the bid and ask price. A liquid ETF will have a tighter bid-ask spread and be cheaper to buy.
3. ETF fees and minimum orders
Remember that even no fee brokers have to pass on ETF fees. Compare fees and minimum orders. An ETF provider, for example, may have a $25 minimum.
Types of ETFs
Exchange traded products track indices (NASDAQ, S&P 500), commodities (the price of gold or oil) and other underlying benchmarks.
ETF Investing by Theme
Here are some popular themes you can track with an ETF:
Invest in a diversified basket of stocks in a major industry sectors or target a hot sector (self-driving cars, robotics). Information technology and healthcare ETFs are currently outperforming other industries.
Over concentration in cyclical industries such as retail and energy that do well when the economy is growing can drag down investment portfolio returns in a slow economy. ETFs tracking indices representing multiple indices such as the S&P 500 diversify this risk. The SPDR S&P 500 Low Volatility UCITS ETF has been a top performer over the last year.
Emerging market stocks benefit from the rapid economic growth of developing economies. By buying a basket of stock indices from different emerging markets, investors can benefit from above average economic growth while reducing price volatility. China A shares and Saudi Arabia are top performing ETFs in the first half of 2019.
ETFs are a good way for the beginning investor to invest in commodities without having to use more complex instruments like futures. Both ETFs and futures are ways to invest in physical commodities without having to transport and own the good. An exchange traded commodity (ETC) is an ETF that tracks a commodity. ETC shares provide fractional ownership in a commodity. An ounce of gold currently costs USD 1,200. One share of the iShares Physical Gold ETC (SGLN) – a top performer over the last six months – represents a 0.020 share in an ounce of gold.
If it walks like an ETF and talks like an ETF, is it an ETF? Flexible ETFs are always innovating to give investors more control over their investment returns.
– SoFi’s GIGE fund for the gig economy lets investors in on deals 31 days post-IPO.
– Salt Financial is paying negative interest rates of 5 percent – in other words, paying you to invest in Salt ETFs.
But investors also need to be on the look out for imitators. Some new products are disguising active funds in ETF wrappers. These fake ETFs plan to compromise some of the features that have made ETFs popular.
– Artificial intelligence ETFs say their bots are so smart they can replace indices, but are these smart bots not machine-learning active investors?
– Non-transparent ETFs aim to report their holdings monthly or quarterly like mutual funds. ETF holdings are always transparent to investors. So you do not have to worry about investing in a value fund and discovering four months later that it has 20 percent of its holdings in declining growth stocks. These opaque hybrid ETFs will be on the market soon.
As a few pretenders join the ETF revolution, keep in mind, the real ETF is transparent, tradeable like a stock and low fee.
Online broker minimum deposits vary. No fee broker models have significantly lowered the minimum. Some allow you to start trading with $5–10. Premium brokers may require that you have not only a high minimum account balance but also meet an asset test (e.g., minimum assets of $25,000].
Low cost index funds and ETFs have pushed the price of investment funds down 40 percent over the last decade. In 2018, the average asset-weighted expense ratio was 0.15 percent for passive funds and 0.67 percent for active funds (Source: Morningstar).
An all out price war among funds has broken out, and investors are the winner. ETFs have the lowest expense fees. But index mutual funds are fighting back. Fidelity has introduced no fee index funds and Vanguard has lowered fees and the minimum investment (to $3,000) to access its lowest cost funds.
Low and no fee online brokers are lowering the cost of buying ETFs. No matter which broker you buy ETFs from, you still have to pay the expense fees. Following are the cheapest funds managers in 2018 (Source: Morningstar Direct Data).
ETF prices vary across investment themes. Management fees are the largest expense component of an ETF fee. An ETF that tracks the S&P 500 index has among the lowest fees whereas ETFs that invest in alternative investments such as real estate investment trusts (REITS) have the highest fees.
ETFs are considered to be tax efficient if they minimize taxable capital gains contributions and distribute qualified dividends subject to lower taxes. To avoid investments Isley made for tax purposes, ETFs must be held for a specified period for dividend payments to qualify for lower taxes.
A margin account allows investors to borrow money from a broker to invest in securities. A broker with 5x leverage allows you to trade 5 times the amount in your account. A $1000 account could trade $5,000. Any gains are multiplied by five, but so too are losses. In the case of losses, a margin call requires you to restore the original value by depositing more money and/or securities in your account.