The Power of Exchange – Traded Funds

In our first blog, we explored how to beat inflation with dividends. Today’s message will show you how to build a diversified portfolio to capture dividends and the growth potential of the stock market. 

There are two onramps to equity investing. The first offers a simple yet elegant approach. The second requires more work, more skill, and more risk. But these three seemingly bad characteristics are counterbalanced by the potential for more reward. 

The first approach is buying a diversified equity portfolio via exchange-traded funds (ETFs).

The second involves stock-picking or purchasing individual companies to try and outperform the market.

It is the latter that commands our attention today. 

What is an ETF?

An Exchange-Traded Fund, or ETF for short, allows you to purchase a basket of stocks using a single vehicle. Sometimes the basket is big. Other times it is small. Some of them are designed to track a particular market segment, like large or small companies. Others are designed to track specific sectors (like energy or financials), countries (like Canada or Mexico), or even entire asset classes (like stocks, bonds, commodities, or real estate). 

Two selling points for using ETFs are diversification and efficiency. For instance, the most popular fund is the S&P 500 ETF, which follows the S&P 500 Index. It trades under the ticker symbol SPY and allows you to buy 500 of the world’s most well-capitalized and well-run businesses—all at the click of a single button. The top holdings include Apple, Alphabet, Amazon, Microsoft, Nvidia, Tesla, and Berkshire Hathaway.

ETFs are the modern-day version of the mutual fund. They have the same advantage as their predecessor but improve upon every disadvantage. 

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Hopefully, the advantages of diversification are obvious. The efficiency perk may not be. Buying SPY is efficient because the alternative is to buy 500 stocks using individual purchases. It would be a logistical nightmare. 

Building a Portfolio of ETFs

New investors should replace the question, “which stock should I buy?” with “which portfolio should I build?” After they learn new strategies and prove they can enhance their returns, they can deviate from the baseline portfolio. Too many people think success starts with picking the best stock or perfectly timing the market. They make what could have been an easy endeavor into a challenging one.

If you’re comfortable with the risk characteristics of the S&P 500, you could keep things simple and use SPY as your vehicle of choice. Wall Street professionals view the S&P 500 as the premier benchmark for the United States stock market. Did you know it’s gone up nearly 600% since the 2009 low? 

Of course, some investors want more geographic and size diversification, so they may add funds of foreign equities, smaller U.S. companies, real estate, or even gold. Here are a few of the more popular choices:

Russell 2000 ETF (IWM): tracks 2000 smaller U.S. companies

Vanguard FTSE Developed Markets ETF (VEA): tracks Foreign Large Cap stocks

iShares MSCI Emerging Markets ETF (EEM): tracks Emerging Markets stocks

Vanguard Real Estate Index Fund ETF (VNQ): tracks real estate

SPDR Gold Shares ETF (GLD): tracks gold

At www.tackletrading.com, we teach people how to create diversified portfolios using stocks and ETFs. We are also offering free live training on April 26th, 2022. Click here to register. 

Coach Tyler Craig

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