You know it is important to do fundamental analysis of stocks which you want to buy into but you are too lazy to do the fundamental analysis for each stock? Well may be you can consider investing in ETF as an alternative or as part of your overall portfolio.
What is ETF (Exchange Traded Fund)?
An ETF is like other stocks traded on the stock market, but it is different from an individual stock in that it is actually a basket of stocks. Do refer to this link for a technical definition.
You can buy ETF which mirrors an index such as DJIA, S&P500, Nasdaq or in the case of Singapore the STI (Straits Times Index). The STI ETF will closely resemble the collective performance and returns of the 30 stocks on the Straits Times Index.
There are two STI ETF in Singapore: Nikko AM STI ETF and SPDR STI ETF traded on the Singapore Stock Exchange. If you want to find out more information and how to trade in these, you can refer to Nikko Asset Management elaborating on Nikko AM STI ETF.
Benefits of ETF
It must be emphasized in case of confusion that ETF is NOT mutual funds or unit trusts, which is a different asset class altogether which personally I avoid especially for those with high sales charges and admin costs, but perhaps this can a subject of discussion in another post.
Generally, an ETF offers these benefits:
- Diversification. If you buy a single stock, the company may go bankrupt. If you are buying say STI ETF, the overall performance reflects how the Singapore economy is doing
- Lower cost of fund management
- East of trading on stock exchange
There are many ETFs which mirror different underlying assets, market index ETF, commodity ETF, Sector and Industry ETF, Bond ETF etc. For the purpose of this article, we have particular interest on market index ETF and will discuss more.
Performance of Index ETF
It may be a little misleading to imply that when you invest into market index ETF, you don’t have to do any homework at all. You would still have to:
- Decide which index ETF to invest in
- Determine when to buy
- How much of your investment portfolio to allocate to ETFs
Each index ETF has a PE ratio. Currently, the US market is trading at about PE ratio of 21 which may be considered high. As a general guideline, a PE ratio of 12 to 15 will be reasonable though there may be reasons to justify a higher PE because of future earnings growth potential.
DJIA has crossed the 20,000 mark and nobody can exactly answer whether the market will remain bullish. It is important however to always remember stock market valuation must be supported by business fundamentals.
The STI ETF currently has a PE of about 13 which is quite reasonable. This also gives you ownership of a well diversified portfolio of Singapore’s 30 biggest stocks such as SingTel, DBS, Keppel Corp etc companies which are component stocks of the STI.
When to buy is a tough decision. When buying index ETF, monthly cost-averaging may be a good approach, especially if you are the type who just wants to passively invest into the market.
ETF As Part of Your Investment Portfolio
Market Index ETF can actually be useful as part of the overall investment portfolio. Some China-specific ETFs are actually quite “cheap” now and I have been adding to portfolio.
If you believe that the oil and gas sector has bottomed out but you are concerned about individual oil and gas stocks and the risks of default, one good way to diversify away the risks but still be vested in oil and gas is buying into an oil and gas sector ETF, example XOP SPDR S&P Oil & Gas Exploration and Production ETF.
If you also use options in conjunction with stock investment, you will be happy to know that ETFs have options on them traded on the options market.
Keep ETF In Your Investment Toolbox
I belive ETF is a great addition to your investment toolbox. However, with risk diversification, you may lose huge returns associated with picking the right winning stocks. Therefore, decide how much of your portfolio you would like to allocate to ETFs and the types of ETFs.
For instance, if you invest in US index ETF, if the average annual return over the next 10, 20 years is going to be about 10% like before, then this is the return you are going to be expecting if 100% of portfolio is invested in it.
In my other post Compound Interest and Einstein, I mentioned to seek a greater investment return over a long period of time to achieve tremendous growth of wealth. ETF is in my opinion a great tool but it is one of several tools I have and I deploy the tools accordingly to maximize my return depending on the situation I am in and the investment objective I try to achieve.
As a quick summary, a short video for you.