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How to diversify with Exchange Traded fund (ETF): Vanguard, iShares, Powershares?

Updated on February 17, 2012
raging bull Wall Street
raging bull Wall Street

Background

Exchange Traded fund (ETF) is an investment fund traded on various stock exchanges. An ETF consists either bonds or stocks or combination between stocks and bonds and trades at NAV (net asset value) of its assets. Most ETFs are tracking an index such as Dow Jones, S&P 500, Russell, and MSCI EAFE etc.

Three reasons why ETFs are attractive compare to typical Mutual funds:

  • ETFs are very tax efficient since ETFs don’t distribute any capital gain for its owner. Typical mutual fund will have distribution of capital gain near end of the year or mid of year.
  • ETFs have a very low cost especially index ETFs. For example, SPY or S&P500 index ETF offer by State Street Global Advisors (SSGA) has only 0.09% expense ratio. The expense ratio is minuscule.
  • ETFs are traded like stock. You can purchase any ETFs during the trading day (pre-market, market and post-market). ETF is very liquid compare to mutual fund. Mutual funds can only be purchased by end of the day.

Similar to Closed-End Fund (CEF), ETFs have similar classifications. They are:

  • Fixed income / Bond: Short term bond, Intermediate term bond, Long Term Bond, Investment Grade, High Yield, Treasury Inflation Protected (TIP) Bond
  • Equity / Stock: Large Cap, Mid Cap, Small Cap, REIT (Real Estate Investment Trust), Emerging Market, Foreign Large Cap, Foreign Small Cap.

Major ETF’s providers are:

  • State Street Global Advisor SPDR such as SPY (S&P500), DIA (Dow Jones Industrial Average)
  • Invesco Powershares: QQQQ (Nasdaq 100 index)
  • Vanguard: VV (Large Cap), VO (Mid Cap)
  • BlackRock ishares: IVV (S&P500), IJR (S&P small cap)

 

Providers

Great ETFs for investment vehicle

I usually buy the following ETFs for my investment account. The ETFs have been chosen due to low expense ratio and their liquidity. Illiquid ETFs can be very hard to trade and bid to ask spread gap can be very large.

Variety of ETFs

(click column header to sort results)
Type  
Fund  
Ticker  
Category  
Provider  
Assets  
Expense Ratio  
Bond
Vanguard Short Term Bond
BSV
Short Term
Vanguard
3.9B
0.10%
Bond
Vanguard Total Bond
BND
Intm Bond
Vanguard
6.8B
0.10%
Bond
ishares TIP Bond
TIP
Infltn Pr Bond
ishares
19.5B
0.20%
Bond
ishares Invest Grade Bond
LQD
IG Bond
ishares
12.6B
0.15%
Bond
SPDR High Yield Bond
JNK
HY Bond
SPDR
3.6B
0.40%
Stock
SPDRS
SPY
S&P 500
SPDR
66.7B
0.09%
Stock
Vanguard Mid Cap
VO
Mid Cap
Vanguard
2.2B
0.12%
Stock
Vanguard Small Cap
VB
Small Cap
Vanguard
3.4B
0.10%
Stock
Vanguard REIT Index
VNQ
REIT
Vanguard
4.7B
0.11%
Stock
Vanguard Europe Pacific
VEA
Frgn Lrg
Vanguard
4.2B
0.11%
Stock
Vanguard Emerging Mkt
VWO
Emer. Mkt
Vanguard
19.1B
0.27%
Stock
iShares MSCI EAFE Small Cap
SCZ
Frgn Small
ishares
0.8B
0.40%

Asset Allocation

You can have an asset allocation according to your risk appetite. I have provided the following sample asset allocation for ETFs. You can tweak as you see fit your long term goal. To have diversification of ETFs is important for long term investor. As you know, similar to mutual funds, ETF also can be clasiffied to various classes such as:

  • Bond ETFs: Municipal ETF, Government Bond ETF, Corporate Bond ETF (Investment Grade or High Yield), Treasury Inflation Protected Securities (TIPS) ETF and more
  • Stock ETFs: Domestic Stock ETF, International Stock ETF, Emerging Market ETF, Secotr ETF, Gold ETF, Silver ETFs and many more

Stock ETF is usually more volatile compare to bond ETF. International stock ETF is also more volatile than domestic stock ETF.

(click column header to sort results)
Type  
Aggressive  
Moderate  
Conservative  
Bond
20%
40%
70%
Stock
80%
60%
30%

Sample of ETFs Diversification

Type
Fund
Aggressive
Moderate
Conservative
Bond
Vanguard Short Term Bond
0.00%
8.00%
20.00%
Bond
Vanguard Total Bond
10.00%
12.00%
25.00%
Bond
ishares TIP Bond
4.00%
8.00%
15.00%
Bond
ishares Invest Grade Bond
3.00%
6.00%
5.00%
Bond
SPDR High Yield Bond
3.00%
6.00%
5.00%
Stock
SPDRS
20.00%
14.00%
8.00%
Stock
Vanguard Small Cap
10.00%
8.00%
4.00%
Stock
Vanguard REIT Index
10.00%
8.00%
4.00%
Stock
Vanguard Europe Pacific
20.00%
14.00%
8.00%
Stock
Vanguard Emerging Mkt
10.00%
8.00%
3.00%
Stock
iShares MSCI EAFE Small Cap
10.00%
8.00%
3.00%
TOTAL
 
100.00%
100.00%
100.00%

Where can I buy ETFs?

Usually you will need a brokerage account to buy ETFs, however, many ETF’s providers recently have provided an incentive by waiving fees to buy or sell ETFs when you open a brokerage account with them. These include Vanguard, Fidelity (ishares ETFs), and Charles Schwab.

If you have $25,000 of money to invest, you can consolidate your account in one of these discount brokerages:

  • Zecco - Good discount brokerage. Decent interface, not the best execution, very user friendly for beginner trader.
  • Wells Fargo Wells Trade account - I never use Wells Trade. My friend has used and found no issue. Very simple interface though.

If you have less than 25k, you can open multiple accounts with Vanguard, Fidelity or Charles Schwab since there is no fees to buy ETFs. I have accounts with Vanguard and Fidelity. Fidelity has good interface for trading. It also provides good research for the ETFs. Vanguard has simple interface and it only offers vanguard ETFs. I also found the quote in Vanguard is not competitive compare to Fidelity.

  • Fidelity - Offer 25 ishares ETF for free. No minimum trading requirement.

Other choices to buy ETFs are discount brokerages such as Just2trade, Lightspeed, optionhouse, sharebuilder, etrade, firstrade, scottrade, etc. Just2trade has the lowest commission of $2.50 to buy/sell stocks/ETFs.


SSO Leverage ETF of S&P 500

Leverage etf
Leverage etf

Leverage ETFs – Never BUY for long term investment

The leverage ETFs usually try to achieve 2x or 3x market index movement (such as S&P 500 index). Two prominent leverage ETFs are Proshares & Direxion. The leverage ETFs can be a bear or a bull fund. I personally avoid buying these ETFs. It is also important to never ever holding leverage ETFs for any long period (more than 5 days). Also, they have high expense ratio (1%-2%).

The following chart will explain why leverage ETF is bad for investment vehicle. As you can see, over the long term the leverage ETFs doesn't follow their index. This happen because of the leverage ETFs were adjusted everyday and slippage occurred.

I did purchase Leverage ETFs from time to time, however this is only high probably trade. I usually only hold these ETFs for day trade or short term trade (i.e. less than 5 days). Only use this investment vehicle if you understand the ETFs.


Any Questions or confuse?

Please leave a comment or message. I'll try to reply. Thanks for stopping by.


Comments

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    • chan0512 profile imageAUTHOR

      chan0512 

      6 years ago from Camarillo, CA

      I think interactive brokers (IB) is good for international investor. Please check my top brokerages article.

    • profile image

      Sunil 

      6 years ago

      Can you please tell us which brokerage is best and cheapest for international investor. One with no hassles, no problems and is easy to use. I want to trade etf, stocks, spreads and futures. Sadsariakaar

    • chan0512 profile imageAUTHOR

      chan0512 

      7 years ago from Camarillo, CA

      If you want a free commission ETF, you can choose vanguard, fidelity, schwab and TD Ameritrade. TD Ameritrade currently offers more than 100 ETFs for free. Or you can select cheap brokerage such as lightspeed or just2trade for trading.

    • profile image

      Dagehter der Peter 

      7 years ago

      I recently moved to the US and am looking for the right brokerage account.

      Could you tell me which broker offers the largest number and variety of ETFs (including international ETFs)?

      Thanks!

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