Home > Articles > Business & Management > Finance & Investing

This chapter is from the book

This chapter is from the book

iMoney: Profitable ETF Strategies for Every InvestoriMoney: Profitable ETF Strategies for Every Investor

Learn More Buy

This chapter is from the book

This chapter is from the book

iMoney: Profitable ETF Strategies for Every InvestoriMoney: Profitable ETF Strategies for Every Investor

Learn More Buy

Index Investing Writ Large: How ETFs Can Be Employed

ETFs got their start in the United States by tracking some of the largest stock indexes—in particular, the S&P 500, the Dow, and the NASDAQ. Since then, ETFs include everything from the smallest public companies to currencies.

Not only are ETFs sprouting up in the areas mutual funds are already covering, but they’re expanding into new ones that were previously unavailable to individual investors, such as foreign currencies and commodities.

Indexes can give you diversified ownership in entire markets in one package, including products that are difficult to invest in outside of futures exchanges. At one time, only the wealthiest of investors could trade in commodities. But ETFs have made it possible for anyone to get in on the game.

Not only can ETFs give you access to investments that mutual funds can’t, but they can be solid, long-term investment vehicles—if you follow our iMoney strategy. ETFs offered in 401(k) plans aren’t widely available yet, although they are becoming more widely known (see Chapter 12, “iMoney ETF Portfolios”). One forward-thinking fund manager created software enabling him to manage a variety of ETFs in 401(k) plans while keeping costs low and active management to a minimum. We think it’s the wave of the future.

iMoney Strategy: Our ETF Analyzer

As long as you are focused on how much risk you can take and have a good idea how to preserve your money for the future, you can ignore the stock market, actively traded mutual funds, and stockbroker and Wall Street recommendations. Pick an ETF that’s broadly diversified, offers low costs, and gives you a break on taxes. How do you gauge the best fund for you? Here are some guidelines for evaluating different ETFs:

  1. How much does it cost? This answer is found in the fund’s expense ratio, a percentage of how much a fund manager deducts annually from your assets. Check the ratios of funds you’re considering against a benchmark. Also, consider brokerage commissions to buy and sell shares. Here are some industry expense averages compiled by Morningstar (www.morningstar.com), a financial information company:

    • U.S. fixed-income ETFs: .29 percent
    • U.S. stock ETFs: .41 percent
    • International stock ETFs: .52 percent

  2. What’s in the portfolio? The fund manager should give you a complete list of securities, the rate of turnover (what percentage of the portfolio is sold off during a year), and the sectors the portfolio represents. A portfolio with 50 stocks or less will be more volatile than one with 500 issues, so keep that in mind when gauging risk. Look for sector weightings, style (growth or value), and composition (percentage of stocks, bonds, cash, and so on).

  3. What’s the risk level? Services and analysts rate risk in a number of ways. One of the most visible is standard deviation, the amount the portfolio’s performance varies from the average of its peers. The higher the standard deviation, the more price variation you can expect. Several services, such as Morningstar, offer risk ratings, although it’s difficult to provide for some of the newer funds. Also, look at the beta, which is how much the fund’s return varies from a market benchmark such as the S&P 500. For bond funds, look at the credit quality, which rates the bonds within the portfolio. This will give you some idea how likely those securities are to default. The higher the letter ranking, the higher the quality; those rated BB or lower are called “junk” bonds, translating to higher-than-average risk. Another measure is called “duration,” which measures how much bond prices will decline if interest rates increase by one percentage point.

  4. What’s the risk-adjusted return? Again, many new funds might not have much history, but you can measure risk-adjusted returns through the alpha. This number tells you how well a fund performed when compared to a standard for its class of funds. The higher the alpha, the better. A negative alpha tells you that maybe the fund took too much risk. Another good test is the Sharpe Ratio, which measures the performance against a risk-free benchmark. The higher the ratio, the better, of course, with 1.0 being excellent. The ratio tells an investor whether a portfolio’s returns are due to wise investing or are a consequence of too much risk.

  5. What is the tracking error? For a fund to fully represent the index it’s intended to track, it must have a high correlation to that index. Funds that perfectly track an index have a tracking value of 100, also known as the highest R-squared, a statistic measuring correlation. Generally, funds with R-squareds from 85 to 100 track an index fairly well. Those below have tracking errors and should be avoided.

  6. What is the tax liability? Few stock ETFs have any tax liability (the amount of capital gains and other taxes generated), but some do. The fund company can give you a breakdown of any taxable distributions. Keep in mind that bond, commodity, and precious metals ETFs have different tax treatments than stock funds. Of course, if you are concerned about taxable gains, you can always place your ETFs within tax-deferred accounts such as individual retirement accounts. Vehicles such as Roth IRAs and Roth 401(k)s allow you to avoid paying any taxes on withdrawals after age 59½. The catch is, you are paying taxes on the money deposited in these accounts.

The next chapter explains the mechanics of indexing and shows you how it works.

InformIT Promotional Mailings & Special Offers

I would like to receive exclusive offers and hear about products from InformIT and its family of brands. I can unsubscribe at any time.

Overview


Pearson Education, Inc., 221 River Street, Hoboken, New Jersey 07030, (Pearson) presents this site to provide information about products and services that can be purchased through this site.

This privacy notice provides an overview of our commitment to privacy and describes how we collect, protect, use and share personal information collected through this site. Please note that other Pearson websites and online products and services have their own separate privacy policies.

Collection and Use of Information


To conduct business and deliver products and services, Pearson collects and uses personal information in several ways in connection with this site, including:

Questions and Inquiries

For inquiries and questions, we collect the inquiry or question, together with name, contact details (email address, phone number and mailing address) and any other additional information voluntarily submitted to us through a Contact Us form or an email. We use this information to address the inquiry and respond to the question.

Online Store

For orders and purchases placed through our online store on this site, we collect order details, name, institution name and address (if applicable), email address, phone number, shipping and billing addresses, credit/debit card information, shipping options and any instructions. We use this information to complete transactions, fulfill orders, communicate with individuals placing orders or visiting the online store, and for related purposes.

Surveys

Pearson may offer opportunities to provide feedback or participate in surveys, including surveys evaluating Pearson products, services or sites. Participation is voluntary. Pearson collects information requested in the survey questions and uses the information to evaluate, support, maintain and improve products, services or sites, develop new products and services, conduct educational research and for other purposes specified in the survey.

Contests and Drawings

Occasionally, we may sponsor a contest or drawing. Participation is optional. Pearson collects name, contact information and other information specified on the entry form for the contest or drawing to conduct the contest or drawing. Pearson may collect additional personal information from the winners of a contest or drawing in order to award the prize and for tax reporting purposes, as required by law.

Newsletters

If you have elected to receive email newsletters or promotional mailings and special offers but want to unsubscribe, simply email information@informit.com.

Service Announcements

On rare occasions it is necessary to send out a strictly service related announcement. For instance, if our service is temporarily suspended for maintenance we might send users an email. Generally, users may not opt-out of these communications, though they can deactivate their account information. However, these communications are not promotional in nature.

Customer Service

We communicate with users on a regular basis to provide requested services and in regard to issues relating to their account we reply via email or phone in accordance with the users' wishes when a user submits their information through our Contact Us form.

Other Collection and Use of Information


Application and System Logs

Pearson automatically collects log data to help ensure the delivery, availability and security of this site. Log data may include technical information about how a user or visitor connected to this site, such as browser type, type of computer/device, operating system, internet service provider and IP address. We use this information for support purposes and to monitor the health of the site, identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents and appropriately scale computing resources.

Web Analytics

Pearson may use third party web trend analytical services, including Google Analytics, to collect visitor information, such as IP addresses, browser types, referring pages, pages visited and time spent on a particular site. While these analytical services collect and report information on an anonymous basis, they may use cookies to gather web trend information. The information gathered may enable Pearson (but not the third party web trend services) to link information with application and system log data. Pearson uses this information for system administration and to identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents, appropriately scale computing resources and otherwise support and deliver this site and its services.

Cookies and Related Technologies

This site uses cookies and similar technologies to personalize content, measure traffic patterns, control security, track use and access of information on this site, and provide interest-based messages and advertising. Users can manage and block the use of cookies through their browser. Disabling or blocking certain cookies may limit the functionality of this site.

Do Not Track

This site currently does not respond to Do Not Track signals.

Security


Pearson uses appropriate physical, administrative and technical security measures to protect personal information from unauthorized access, use and disclosure.

Children


This site is not directed to children under the age of 13.

Marketing


Pearson may send or direct marketing communications to users, provided that

  • Pearson will not use personal information collected or processed as a K-12 school service provider for the purpose of directed or targeted advertising.
  • Such marketing is consistent with applicable law and Pearson's legal obligations.
  • Pearson will not knowingly direct or send marketing communications to an individual who has expressed a preference not to receive marketing.
  • Where required by applicable law, express or implied consent to marketing exists and has not been withdrawn.

Pearson may provide personal information to a third party service provider on a restricted basis to provide marketing solely on behalf of Pearson or an affiliate or customer for whom Pearson is a service provider. Marketing preferences may be changed at any time.

Correcting/Updating Personal Information


If a user's personally identifiable information changes (such as your postal address or email address), we provide a way to correct or update that user's personal data provided to us. This can be done on the Account page. If a user no longer desires our service and desires to delete his or her account, please contact us at customer-service@informit.com and we will process the deletion of a user's account.

Choice/Opt-out


Users can always make an informed choice as to whether they should proceed with certain services offered by InformIT. If you choose to remove yourself from our mailing list(s) simply visit the following page and uncheck any communication you no longer want to receive: www.informit.com/u.aspx.

Sale of Personal Information


Pearson does not rent or sell personal information in exchange for any payment of money.

While Pearson does not sell personal information, as defined in Nevada law, Nevada residents may email a request for no sale of their personal information to NevadaDesignatedRequest@pearson.com.

Supplemental Privacy Statement for California Residents


California residents should read our Supplemental privacy statement for California residents in conjunction with this Privacy Notice. The Supplemental privacy statement for California residents explains Pearson's commitment to comply with California law and applies to personal information of California residents collected in connection with this site and the Services.

Sharing and Disclosure


Pearson may disclose personal information, as follows:

  • As required by law.
  • With the consent of the individual (or their parent, if the individual is a minor)
  • In response to a subpoena, court order or legal process, to the extent permitted or required by law
  • To protect the security and safety of individuals, data, assets and systems, consistent with applicable law
  • In connection the sale, joint venture or other transfer of some or all of its company or assets, subject to the provisions of this Privacy Notice
  • To investigate or address actual or suspected fraud or other illegal activities
  • To exercise its legal rights, including enforcement of the Terms of Use for this site or another contract
  • To affiliated Pearson companies and other companies and organizations who perform work for Pearson and are obligated to protect the privacy of personal information consistent with this Privacy Notice
  • To a school, organization, company or government agency, where Pearson collects or processes the personal information in a school setting or on behalf of such organization, company or government agency.

Links


This web site contains links to other sites. Please be aware that we are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of each and every web site that collects Personal Information. This privacy statement applies solely to information collected by this web site.

Requests and Contact


Please contact us about this Privacy Notice or if you have any requests or questions relating to the privacy of your personal information.

Changes to this Privacy Notice


We may revise this Privacy Notice through an updated posting. We will identify the effective date of the revision in the posting. Often, updates are made to provide greater clarity or to comply with changes in regulatory requirements. If the updates involve material changes to the collection, protection, use or disclosure of Personal Information, Pearson will provide notice of the change through a conspicuous notice on this site or other appropriate way. Continued use of the site after the effective date of a posted revision evidences acceptance. Please contact us if you have questions or concerns about the Privacy Notice or any objection to any revisions.

Last Update: November 17, 2020