This weekend I was looking over my investment accounts at Zecco and thought now would be a good time to diversify into a Financial sector Exchange Traded Fund(ETF). My investment portfolio currently consists of several mutual funds, a few individual stocks, and only one ETF. My ETF is VHT, which is the health care sector fund from Vangaurd (VHT).
The first step is to decide what you want. I bought VHT more by accident that planning, because what I really wanted at the time was the Vanguard mutual fund that it tracks. When I first spotted the mutual fund, it had an initial minimum investment $20,000, which was almost my annual salary at the time. When I looked again a few years later it had become closed to new investors. So I bought the ETF instead. Now I take a look around at the beating the financial industry has taken, and I'm thinking that it is almost ripe to invest in. The failure and take over of IndyMac bank by the FDIC this weekend will probably have some repercussions on market in the next few weeks, but I don't think there is much more room to go down (famous last words in finance). The reason I wanted to buy the Vanguard health fund? Because baby boomers are getting old and need health care. So if you spot a trend you think you can make money on, there is probably an ETF out there to support you, whether it is the aging of America or the rise of nuclear power as an alternative to oil (NLR to name one). Or you could just go for the broad market (SPY)
Once you have an idea of what you want, you can go to a financial site and search for more specifics. I'm going to use Yahoo! Finance because I'm partial to them. Go to the Yahoo! Finance site, hover over investing, and select the ETFs option.
Click on the View ETF's link to see all the ETFs. Select the category of funds you are looking for an them press the view button. Or if you are partial to a particular company, you can sort by family. There may be a lot to choose from. The way to narrow your selection down is by looking at critical factors.
The same critical factors that apply to mutual funds and stocks apply to ETFs. For instance, the trading volume and net assets. A low trading volume and low net assets could hurt you when you want to sell your shares at a later date. Low volume (for example < 100,000 shares per day) or low net assets (for example < $250 Million) could mean that you will not find any buyers when you need to sell.
Another very critical factor is the expense ratio. Just like mutual funds, ETF's have expense ratios to cover the cost of managing the ETF. Typically these cost are lower than a similar mutual fund.
Lets take a closer look at one of the ETFs. I'll examine Ultra Finacials ProShares (UYG) in more detail. When you click on it you get the summary page, which has several bits of useful information. Last Trade tells you what you can expect to pay for the ETF currently. NAV is Net Asset Value(NAV), which is the value of all the underlying stocks that comprise the ETF. Notice the stock price is higher than the NAV. This means it would be cheaper to buy the stocks individually (not counting broker fees). That is not a good sign. Since ETFs are very easily traded, it means the stock value will most likely come down in line with the NAV. Net Assets of over 1 Billion mean there should be good liquidity in the fund( it is easily traded on the market). P/E is a statistic usually associated with an individual stock. It is the Price to Earning ratio, and it is a measure of how expensive the stock is. P/E ratios are typically between 10 and 20 for healthy companies. Lower than 10 means that the company is undervalued, or in some kind of financial trouble. For ETFs , the P/Es of the all the stocks in it are considered. A P/E of 13 could be good, but other ETFs in the same sector have even lower P/E's right now, so that may not be a value after all.
The profile tab also has some very good information. The Yield shows how much you can expect to get in terms of income from dividends or interest payed on the underlying stocks. While 3.8% is higher than the total market, it is not out of line for the financial sector. A higher yield means it would be better to put this ETF in a tax advantaged account like an IRA to avoid paying taxes on the yield. The fund summary tells you the funds overall strategy.
Fund Expense Ratio and Turnover are two very critical elements. An expense ratio of 0.95% means you pay 0.95% of your assets annually in fees to the fund. This cuts into your potential gains. That kind of expense ratio is normally seen by an actively managed mutual fund. For an ETF you should expect < 0.5%. Also, with a turnover ratio of 46% percent, there are a lot of active trades going on inside the ETF. Active trades incur fees and taxes. In essence, the fund is all new every 2 years. You should look for a turnover ratio of 10-20% or less.
The holdings tab is also something to consider. For example, I already have a stake in Citigroup through individual share purchases, so a fund that holds a large percentage of Citigroup would not appeal to me.
Overall I would not buy UYG. There were two other funds I looked at that better meet my criteria. They are XLF from the people who brought you spiders, and VTI from Vanguard. Not surprisingly, Vanguard's ETF looks the best to the me, but XLF is almost the same. I'll be watching it closely over the next few weeks.
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