How To Pick A Winning ETF

Written by Julie Brownlee on March 24th, 2017

How To Pick A Winning ETF

Investing in the stock market gives your capital an excellent opportunity to grow handsomely over the years ahead.

But what if you’re not much of a stock picker?

Maybe you don’t want to dedicate the time and effort it takes to find quality shares to invest in.

Or perhaps you simply just don’t want to.

Well, don’t fret.

This is where exchange traded funds (ETFs) can play an important role.

So what are these funds?

And how can you find the best ones to invest in?

Let’s find out…

 

What Is An ETF?

 

ETFs are investment products that list on a stock exchange, such as the JSE.

Their mandate is to track a particular index. This is dependent on each individual ETF.

Making up ETFs is either shares, bonds or commodities.

For instance, a JSE Top 40 ETF aims to track the performance of the JSE Top 40 Index.

An ETF contains the same weightings of securities as its underlying index.

Investing in these funds is exactly the same as investing in shares.

By purchasing a particular ETF, you gain exposure to the different securities making it up.

ETFs are very similar to passively managed unit trusts.

 

 

Why Invest In ETFs

 

There are a number of advantages to investing in ETFs, including…

  • ETFs give you exposure to many different securities so provides you with instant diversification.
  • They’re exchange traded, so you can easily buy and sell them through your stockbroker or dedicated ETF investment company.
  • As you’re buying an index tracker, it makes selection much easier than buying individual shares.
  • And they’re a cost effective way to invest.

So how can you find the best ETFs for your portfolio?

By filtering through what’s on offer and doing some analysis…


Investing In ETFs Step #1: Check Your Asset Allocation

There are a variety of ETFs tracking a number of different markets and sectors.

So to begin investing in ETFs, you first need to decide what you want to buy.

For instance, you may decide that you want a broad market tracker, plus exposure to particular sectors, such as property and financials, and offshore.

Have a look at what’s on offer within which market, index or sector you want exposure to.

A good started point is etfSA.co.za. Here you’ll find all the ETFs listed in South Africa.

Through investing in ETFs, you can build a well-diversified portfolio.

You want a good spread of different assets, just as you would with building a portfolio of individual stocks, bonds and commodities.

For instance, your attitude to risk will help you decide what proportion of stocks to bonds you want exposure to.

There are different bond ETFs to invest in, as well as shares.

You need to check the compositions. You can do this easily from looking at the asset allocation of an ETF in its fact sheet, which we’ll look at in a moment.

Aim to have exposure to…

  • Stocks, including different sectors, such as property, financials and industrials;
  • International stocks;
  • Bonds; and
  • Commodities.


Investing In ETFs Step #2: Do Your Research

Just like unit trusts, all ETFs have a fund fact sheet.

You can find these fact sheets on the provider’s website or through a site like etfSA.co.za.

This gives you a wealth of information, including:

  • An ETF’s ticker code;
  • The index it tracks;
  • Its total expense ratio (TER);
  • If it makes any distributions (dividend payments) and if so, how often;
  • Its risk profile;
  • The top ten securities in the fund ;
  • And returns over one, three and five years, plus since inception.

You can use this information to help you decide which ETFs you want to buy…


Investing In ETFs Step #3: Look At Costs

Like everything else investment, there are costs to consider with ETFs.

This is where you need to pay attention to TER, which, as we looked at above, you’ll find on a fund’s fact sheet.

Costs eat into your returns, so it’s important to look at them.

The TER includes the costs associated with investing in an ETF, but it doesn’t include the cost of actually investing.

In other words, it doesn’t take account of the fees and charges you’ll pay your stockbroker or trading company to buy and sell the fund for you.

But what the TER does include is:

  • Management fees;
  • Bank charges;
  • Taxes;
  • Fees involved with the fund; and
  • Administration charges.

The lower the TER, the lower the overall costs of the fund.

As ETFs are passive funds, you should look for the ones offering the lowest TER.

But…


Investing In ETFs Step #4: How Well An ETF Tracks

The goal of an ETF is to track its underlying index, so this is something you must check.

You can see how well an ETF is doing this by looking at the performance section on its fact sheet.

Of course, you have to expect a little bit of difference, but an ETF should track its index closely.

If you have a few options for a particular type of ETF, you want to compare the differential.

If a fund is underperforming its benchmark, but its costs are lower than one that’s tracking more accurately, you may be better off paying the higher costs.

Make sure you look at the differential over a decent time period before making your decision.

 

Create Your Winning ETF Portfolio

 

Using ETFs to build an investment portfolio is certainly much easier than picking individual shares.

If you focus on the aspects we’ve looked at, you’ll be able to find the best ETFs on offer for you.

Then it’s a case of sitting back and letting the market do the hard work for you over the years ahead.

Don’t forget, as with investing in shares, selling your holdings of ETFs could create a capital gains liability.

As it currently stands, you have an annual allowance of R40,000.

Capital gains over this are taxable at 18%.

Of course, you could use your tax free savings account to apportion some of your ETF investments, making any future gains free of tax.

Just remember, there’s an annual limit of R33,000, capped at R500,000 over your lifetime.

By spending a little bit of time, you can create a balanced portfolio that will reward you in the years ahead.

ETFs are a great way to create a winning long-term portfolio.

Until then, here's to profitable investing. 

Julie Brownlee | The Money Lab

Julie Brownlee
Editorial Contributor
The Money Lab