Exchange-Traded Funds or ETFs are becoming more popular among those who want to break away from traditional mutual funds but aren’t quite ready for handpicking individual stocks for their portfolio.
ETFs are low cost, tax-efficient, liquid, provide diversification, and are in general just better-suited to a lot of people.
Today, we’ll be having a conversation with Kyle Woodley, senior investing editor at Kiplinger.com, on the best ETFs he recommends for 2021.
We’ll be going through all the topics regarding ETF investing, how they are different than mutual funds, who should invest in them, and how to select the best ETFs out there.
So first of all, let’s begin by understanding what an ETF is? And how is it different from mutual funds and individual stocks?
Difference Between ETFs and Stocks
ETFs, just like mutual funds, are a basket of securities that lets you invest in a variety of assets. The only difference being that ETFs trade on stock exchanges like individual stocks, and you can buy and sell them with the help of your broker.
The major difference between investing in stocks and an ETF is the risk and reward they offer. A single stock is likely to have much more upside and downside potential than any sort of fund, whether a mutual fund or an ETF.
In the case of an individual stock, your portfolio performance completely depends on the movements of that stock. However, in case of funds, a fund would probably invest in 30, 50, 100, or even more companies that significantly reduce the risk as well as the return potential.
Now, it goes without saying that there are exceptions to the aforementioned statement. For example, Cocacola probably will not move as much as a clean energy ETF. But in most cases, a fund will not be as concentrated as a handpicked portfolio.
The advantage of not having a high concentration is that you get diversification that protects you from higher risk. The flip side, though, is if you’re trying to generate outflow and outperform the market, then it’ll be much easier with an individual stock that can, you know, go to the moon.
To summarize, if you know what you’re doing and you have a good eye for selecting stocks, then maybe individual stocks are better for you. But if that is not the case, then ETFs might make the most sense.
Difference Between Mutual Funds and Stocks
At the very basic level, both are funds that collect a pool of some sort of assets and allows you to invest in them very easily, of course for a fee.
So whether it’s a mutual fund, a closed-end fund, or an ETF, you can invest in a basket of stocks, bonds and other things.
The very first difference between a mutual fund and an ETF is that an ETF trades on an exchange, hence the name exchange-traded fund, while a mutual fund doesn’t.
That might not be a make or break thing for many people, and it is not important either because the only reason that matters is, you might get a little bit of a better buying price during the day. A mutual fund, on the other end, just settles once every trading day, and you can only buy at that price.
Since ETFs trade on an exchange, that obviously makes them more tradeable and theoretically also allows day traders to trade them.
Now, the thing that matters to most people is cost and expenses. The reason why most ETFs tend to cost much lesser than mutual funds is because most ETFs are index funds. In other words, they’re not actively managed.
Whereas most mutual funds are actively managed by highly-paid managers to beat the general market returns, which obviously costs much more to run than an index fund or ETF.
There’s also a major difference in the transparency of a mutual fund and an ETF. A mutual fund is only required to release its holdings every quarter, while an ETF gets updated every day.
It is also a major advantage with an ETF because you can actually go to the ETF’s website and check its holdings to see if their investments make sense to you.
Does Investing in Mutual Funds Make Sense?
Ok, so ETFs are low cost, tax-efficient, diversified, and provides several benefits over a mutual fund. So does investing in a mutual fund even make sense? If yes, then for whom and in which cases?
Well, if you’re investing in a mutual fund, don’t worry because you’re not making a stupid decision. While it might look like ETFs are the replacement for mutual funds, mutual funds have their own merits too.
Mutual funds are actively managed, and some of them are managed so well that they actually beat the benchmark. If you can find good management in a mutual fund, then most probably it’s worth the extra cost.
Also, you tend to find the outperformance more in areas that are specialized and have room for growth. For instance, it’s difficult to find outperformance in large-cap stocks.
So when it comes to small and micro caps where the research of these fund managers actually makes a difference, mutual funds can be a really good option.
If you have a 401k, then it becomes necessary for you to have a mutual fund because very few 401k plans allow you to have an ETF. So that’s your only option left.
How to Find the Best ETFs
There are several thousand ETFs out there so it’s definitely hard to choose the one that will be a perfect fit for you.
If you’re just beginning from scratch and trying to find out what’s out there, then the first thing to do is find an ETF screener. The screener won’t tell you the best ETFs, but it’ll give the universe of ETFs that exists for what it is that you’re looking for.
There are several free ETF screeners out there that you can use. The one that Kyle recommends is ETFDB.com, but you can really use any one of them.
The screener will give you a basic idea such as how big the fund is, what the expenses are, what the dividend yield is, and things like that. After that, you can decide what it is that you want to see in your portfolio. Which area, industry, economy do you wanna target?
If, for example, you have a tech-focused portfolio that you’d like to diversify with some healthcare stocks, but you don’t know much about the healthcare industry. Targeting a healthcare ETF might be really good idea.
Another good reason to opt for an ETF is when you wanna invest in a risky industry that is hard to research about yourself. Yes, Marijuana is a perfect example. In such cases, an ETF would make the most sense.
Kyle’s Best ETF Picks
Every year at Kipinger.com, they come up with a “Best ETFs for the year” edition on their blog. You can go and read that yourself we’ll provide you the link. But for now, let’s ask the writer of this year’s edition, Kyle himself, to summarize the list.
But before getting into that, remember that not every pick in the list is going to do well necessarily in 2021, and not each one of them will do well for the entirety of 2021. The list is created keeping in mind the trends of the future.
So, every year when they make this list, the number 1 spot is always taken by VOO, which is the Vanguard S&P 500 ETF. The reason is that everyone should start with a core, and any S&P 500 ETF is a great core.
If you have your core sorted and wanna get into some strategic ETFs, then value ETFs are something you should look into. It’s one of the biggest trends in 2021 because value stocks are expected to outperform this year. There are two value ETF picks on the list, the Vanguard Value ETF (VTV) and Distillate U.S. Fundamental Stability & Value ETF (DSTL).
The latter one i.e., Distillate U.S. Fundamental Stability & Value ETF is a unique and one-of-a-kind value ETF because instead of focusing on traditional value metrics like PE, PB, PEG, etc. It focuses on free cash flow, which is a more reliable value metric.
Another unique fund on the list, which is a leveraged fund, is ProShares Short S&P500 ETF (SH). As the name suggests, it is a short fund and a hedge against the market. It gives you the inverse returns of the S&P 500.
Now, shorting the biggest economy in the world might sound like a stupid idea, but it’s actually a very responsible hedge. If you’re an investor, it may not be for you. But if you’re someone who thinks you can time the market or you wanna survive a market crash without selling your portfolio, SH is a great option.
Now, if you’re interested in learning more and wanna read the complete list of Best ETFs for 2021. Then you can read the full version of Kyle’s article by clicking here.