The basics of a good ETF investing strategy

Investors confused by the plethora of stocks available to build a balanced portfolio often turn to funds as an alternative. That’s when they discover that there seems to be more funds available than the underlying securities they represent. Investment author Jeana Deal helps narrow down the offerings in choosing the best ETFs.

If you can’t beat the market, then buy it. Buying an exchange-traded fund (ETF) is often the alternative choice among investors who understand too well the challenges of outperforming the market.
It’s hard to argue against the convenience of buying an ETF that consists of the stocks in your index of choice. In addition to that, you have the benefits of professional fund management, diverse asset holdings, lower management fees, and fewer commission charges.

ETFs come at a cost

The popularity of ETFs, however, comes at a cost. With so many similar ETFs to choose from, the selection process resembles the onerous task of stock picking—which is exactly what fund investors are trying to avoid in the first place.

Narrow down choices

Provided that ETFs are similar in fund objectives and asset holdings, I prefer to narrow down comparable choices by first focusing on those ETFs with higher trading volume. Trading volume isn’t necessarily an indicator for good performance, but I personally like to use it to find more popular choices in the markets for comparison purposes.

Then, I try to identify opportunities by analyzing the technical information provided by price history charts.

The Canadian stock market had a rough start to 2016 due to the under-performance in the oil sector and its depressing effects on the Canadian dollar. We’ve seen incredible recovery since the market lows of January.

From a technical perspective, I advise investing in Canadian market index funds with caution as the market has been moving in an upward trend since January.

The correction in late June—triggered by the Brexit referendum results—was brief and actually provided another buying opportunity in stocks. The market is still bullish, but investors entering at this point might want to take less risk until the next major correction in the market provides new entry points.

Desirable ETFs

Here are some Canadian index ETFs to consider: Vanguard FTSE Canada All Cap Index (TSX—VCN), iShares Core S&P/TSX Capped Composite Index (TSX—XIC), iShares S&P/TSX 60 Index (TSX—XIU), and BMO S&P/TSX Capped Composite ETF (TSX—ZCN).

These ETFs are all advancing towards previous highs in areas where there will likely be some sell-off. If, however, the US market continues on its bullish trajectory, then these ETFs will likely follow suit.

A well-diversified fund portfolio should have some foreign holdings. The U.S. market continues to display optimism as the S&P 500 Index is now above its 2015 highs and beyond resistance levels that would otherwise impede its performance.

It’s impossible to predict if and when there will be a correction in the next quarter or two, so it’s prudent to also have a closer look at some of the other major U.S. market indices.

The NYSE Composite Index and the Russell 2000 Value Index reveal the same challenges as the Canadian market indices where they’re approaching previous resistance levels and will likely experience some sell-off. The NASDAQ Composite is extended having gone straight up for six weeks and is due for some sell-off relief soon—or at least a period of sideways consolidation—before resuming its upward trend.

Timing market entry is even harder than stock picking. Investors looking for the ease that ETF investing offers will likely not have the same time commitments to watching the markets closely. My advice is similar to that for entering Canadian index ETFs which is to take lesser risk.

Vanguard has a few solid U.S. market ETFs to choose from such as the Vanguard U.S. Total Market Index ETF (TSX—VUN). A depreciation in the U.S. dollar against ours will impact the value of U.S. holdings, so there are Canadian dollar-hedged options by Vanguard as well. Vanguard offers its U.S. Total Market Index ETF CAD-hedged (TSX—VUS) and the S&P 500 Index ETF CAD-hedged (TSX—VSP).

Global markets in an ETF portfolio

To create a well-balanced market portfolio, investing in global markets is an important consideration. Global markets often lag the US market, but the point of diversifying is to try to make money all the time, or at the very least, most of the time.

The cyclical nature of money coming in and out of investments means even the strongest economies undergo slower periods in their cycles. This makes way for investing in defensive industries, as well as in lagging sectors and foreign markets, as they present new opportunities. Having foreign holdings other than just U.S. assets may contribute to a more consistent performance in your overall portfolio. Investors can choose to invest internationally in developed markets, emerging markets, or both.

Things to watch out for

When looking for global index ETFs, it’s good to keep in mind that they generally don’t tend to trade in high share volume. My favourite technical charts so far are the Vanguard FTSE Developed All Cap ex U.S. Index ETF CAD-hedged (TSX—VEF) and the Vanguard FTSE Developed All Cap ex U.S. Index ETF (TSX—VDU). There is also the Vanguard FTSE Global All Cap ex Canada Index ETF (TSX—VXC) which invests in holdings from developed markets (including the U.S.) and from emerging markets.

As earnings from foreign assets in ETFs will result in fully taxable income and withholding taxes, these are better suited for investing in appropriate registered accounts.  Beyond investing in the stock markets, other investment objectives may be accomplished through ETFs concentrated in different fixed-income and dividend options, specific sectors and industries, commodities, as well as foreign currencies. It is possible to achieve a well-diversified portfolio consisting only of ETFs.

Investing in ETFs is less about the strategy of just buying the seemingly unbeatable market. Investors are becoming more sophisticated in creating their own well-rounded portfolios which has led to further developments in investments—and a multitude of ETF options to choose from.

In recent years, August has superseded September (and October) as a month where global stock markets experience unusual volatility due to jittery investors jettisoning equities.

Jeana Deal is the author of Loonie to Toonie—Financial Basics for Canadians. She lives in southern Ontario and trades and invests in Canadian and US stocks for her own investment account. You can visit her website loonietotoonie.com to read more about her investment ideas.

 

Investor’s Digest of Canada, MPL Communications Inc.
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