How to choose from among so many Index funds and exchanged traded funds?
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The author of this website recommends equity exposure through index funds and exchange traded funds as opposed to direct stocks ownership (if not enough capital) and actively managed mutual funds. See that there are basically only three ways to own stocks, not considering an investment linked insurance policies that invest some of the policy holders’ premiums in equities.
As of now, there are more than 1000 index funds and exchanged traded funds available in the United States, without including other countries. Out of these 1000 passively managed funds, around 300 consisted of index mutual funds and more than 700 exchange-traded funds. The number of such funds will continue to increase as a result increasing popularity of average investors in them. With so many funds available, it will be hard to choose from without some reasonable guidelines, just like housewives choose apples and oranges in the supermarket with some “quality control” criteria also.
1. Begin with the end in mind – begin with the type of needs required for your investment dollars
Steven Convey seven habits of the highly effective people apply to almost everyone and everywhere. In the investment universe for paper assets, not considering real estate and real estate related intangible assets like real estate investment trusts (REITs) and exotic investments like wine or fine arts and commodities, there are basically only two choices to grow your wealth – stocks and bonds.
The deciding factor between these two major categories is simply whether the investor involved wants more growth over the long run or stability in returns. It is a well known fact that stocks achieved much higher total returns when measured over a long investment horizon of more than 10 years. The higher returns of stocks come from both capital appreciation and dividends receive along the way. As for bonds, the income from coupons payments is rather consistent and there is clearly a limit to the value of bonds as they ultimately can only be redeemed at face value when the bonds reached maturity date.
Everyone has different needs for each percentage of their investment dollars, especially if already got a portfolio of stocks, by right, theoretically speaking, one should invest in others like bonds, to balance the portfolio. As a result, even when it comes to index funds/exchanged-traded funds, the first issue to consider is basically what you needs.
Even within these two broad categories of paper assets, there can be even greater diversification, like in terms of market capitalization, for example, like allocating between blue chips and small caps, other than diversified using different geographic regions.
As you can see, even for passively managed funds, it begins with your needs.
2. Index mutual funds or exchanged-traded funds?
The difference between index mutual funds and exchange-traded funds (ETFs) lies in the former is not listed on stock exchange while the latter is. For the case of index mutual funds, its value is determined using net asset value while the price of one share of exchanged-traded funds changes throughout the day depending on market sentiments.
In general, ETFs have lower operating expenses than index funds but cost some dollars to buy and sell. Hence, they are better options for dollar cost averaging during bear market, after purchasing, buy and hold for the next 10 years or more until retirement. When it comes to dollar cost averaging all the time from regular contributions from paychecks and IRAs accounts, even when stock market is clearly overheated, then index mutual funds may be better.
This will depends on each individual investing strategies based on the fundamental differences between these two types of passively managed funds.
3. Owning businesses or investing, bottom line is always crucial.
After deciding on the index and whether index funds or ETFs, there will most probably be many funds offered by many companies in this wealth management industry that tracked the same index. By right, from the definition of index funds and ETFs, all the index funds/ETFs should be almost the same. If they are the same, why on Earth should you choose one that charges high upfront load and higher annual operating expenses than the others?
This is like buying apples and oranges higher in this supermarket when the supermarket next door sells the same apples and oranges that come from the same farms for significantly lesser.
4. Closely examine the index that the index fund/ETF tracks
At the end of the day, an index fund/ETF can only do as well as the index that it represents, minus the operating expenses of course. There are many well known and lesser known indexes after Dow Jones Industrial Average and S&P 500.
Take a look at the top five factors in choosing an index to invest in, though they may not be comprehensive.
5. Estimating returns of the index fund/ETF
As I mentioned above, the returns of index fund/ETF cannot exceed the returns of the index that it represents. How well the index fund/ETF do depends on the index and most important, timing of entry and exit, while most, if not all, cannot accurately predict the exact top and bottom. It is definitely possible to as least know where the top and bottom areas lie. Timing of purchases should be done near the bottom. Do your market timing in years, not seconds, minutes, hours, days and even months. Spend your life starting and engaging in part time businesses or professions that generate the cash, not watching stock tickers. You incur less transactions costs also.
In addition, by looking at the historical returns and trends from the indexes that the index fund and ETFs tracks assist a lot in gauging the risk and return since most ETFs are less than 10 years in existence.
In general, stocks are expected to perform better than bonds when measured over long periods of time but the downside is greater volatility. Then under stocks, small caps are also expected to return more than large caps in the same long periods, but with greater volatility also.
Then how long is long?
Long in this context should be at least 5 years or more.
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In truth, immediately i didn’t understand the essence. But after re-reading all at once became clear.
In truth, immediately i didn’t understand the essence. But after re-reading all at once became clear.
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