ETFs: Exchange-Traded Funds

Efficiency and diversification at a low cost

ETF stands for Exchange-Traded Fund. Technically it’s a fund that works just like any other stock. It can be bought and sold as long as the market where the share is listed is operational.

Nowadays, ETFs have become popular because they offer the possibility of obtaining high diversification instantly and for a lower cost than managed funds.

ETFs can cover multiple strategies. The most popular ETFs are those that follow a particular index. These ETFs are extremely useful if we want to be exposed to the entire index and there’s always the option to have it at a very low cost. As we are buying the ENTIRE index we implicitly buy all values that make it up.

John Bogle, Vanguard’s creator and one of the ETFs largest providers, is a staunch advocate of this instrument. In his book (which we highly recommend) he proved that historically most funds have not been able to beat the market they follow so they don’t add value for the investor. Regardless of the fund manager’s success, there are several reasons but the most significant reason is the high cost associated to the investment fund management. It is not the only one; he also mentions the tendency of managed funds to make excessive transactions which have an impact on the costs and taxes or the legal constraints that cause managers to lose flexibility.  As a result only 10% of managed funds beat their reference “benchmarks” (or indices). In the long-term (if they persist in this time frame) those who succeed are negligible.

As it can be seen in a recent report, this continues to occur.

Therefore, if we for example buy an S&P500 ETF we will have better results than most of the investment fund managers. ETFs procure a 99.95% return of the market’s performance; the main difference is due to its costs, which typically range between 0.05% and 0.10% (taking into account this index).

The main difference between ETFs and mutual funds (active and indexed) is that investors buy and sell ETF shares together with other investors in a stock market. As a result, the ETF’s administrator doesn’t have to sell shares (it could lead to capital gains) when an investor decide to sell ETF shares.

Investment fund shareholders amortize shares directly from the fund. The fund’s manager must sell fund values to cover the funds redeemed by the investor and that could lead to capital gains that would affect all of the fund’s shareholders. For that matter using ETFs might be fiscally more efficient as an investment tool.

Furthermore, ETF shareholders could suffer fiscal consequences when selling shares on the stock market. However, these consequences wouldn’t affect other shareholders of the ETF. Funds have some advantages in a few jurisdictions: in the case of a fund transfer they are exempted from taxation and funds also receive a more beneficial tax treatment compared to any investment transfers (buy/sell) that are made directly on the market.

Where to invest, Inbestme’s Scope:

To sum up, ETFs can be understood as a basket with assets that gives us specific exposure to a type of asset. ETFs are a priority in our diversified portfolios because they allow a broad diversification, like in the case of mutual funds but at a much lower cost and with total liquidity, transparency and better profitability.

Therefore, ETFs can be considered the basis of our investment strategy. By combining different ETFs we are able to build efficient portfolios that suit our customers profile risk and at a very low cost.

We combine optimal portfolios with ETFs from different types of assets and markets.

We select those ETFs that have proven to be more efficient and that usually match the ETFs with lower costs. Inbestme is constantly evaluating ETFs in order to search for greater efficiency; however, the ETFs that we pick ETFs are completely independence. We try to avoid sophisticated ETFs (they are usually much more expensive) because it has been shown that they aren’t successful.

We combine low correlation ETFs following the Modern Portfolio assumptions.

However, our management isn’t limited only to evaluating ETFs: it is a dynamic management that seeks to suit our investor’s profile taking into account any market situation. This fact, allows us to perform opportunistic investments to which we allocate between a 10% and 15%, searching for profitability or additional coverage.

In exceptional situations we also apply a dynamic model that enables us to protect our portfolios from dramatic falls.

Portfolios are rebalanced periodically as well, which adds an additional profitability.

Inbestme is your digital financial advisor. We help you invest better and to take better control of your finances.

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Index funds, etfs and pension plans

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