Did you know there are more indices than stocks currently? That means the total number of indices you can buy is more than the total number of stocks you can buy.
Stock index (indices in plural) are used as indications of a stock market. This is usually done by focusing on a selected section of the stock market. An example is the Straits Times Index (STI), which is used as a benchmark of the Singapore stock market.
In a nutshell, indices indicate the performance of the underlying market it is tracking. And, investors can invest directly into indices through a product known as the Exchange Traded Fund (ETF).
It is like a mutual fund, except fund managers only need to follow the index that it is trying to replicate without having an army of analysts. This means lower fees and more profit in the pocket for investors.
With so many indices in the market, it is not surprising that the number of ETFs available to investors outnumbers that of stocks.
But, does that mean it’s harder to choose an ETF than stocks? Of course not. ETFs, give investors exposure to a basket of stocks, which lowers the risk.
Even then, how do we know what ETFs to pick? I had the chance to hear Alvin Chow, the CEO of Dr Wealth, speak at The Fifth Person’s InvestX Congress 2017 on 19 August 2017.
In this article are three nuggets of wisdom I gleaned from his talk and how it could help you make better decisions when looking at ETFs to invest in.
1. ETFs work on the concept of natural selection
The STI and other indices around the world follow a certain rule, and when constituents don’t meet the requirements, they will be removed from their respective indices. The role of ETFs is to track their respective indices and do the same.
In this respect, ETFs work on the concept of evolutionism or natural selection, says Alvin. Therefore, investors get exposure to only the stocks that fall within certain criteria set by the indices.
Most major indices, if not all, may face corrections whenever there are crises. But over the long term, investors who hang on will make decent returns, albeit lesser than picking individual stocks.
Remember, though – no one can predict how the market will move. And for retail investors with little time on their hands to do research, investing in stocks blindly or limited information is akin to gambling.
Thus, for retail investors with little knowledge about individual stocks but still want exposure to a certain sector, country or even factors, ETFs are safer than individual stocks.
2. Thematic ETFs give exposure to current or upcoming trends
In this day of age where technology has changed so much of our lives and will only continue to have increasing impact, long standing industries getting disrupted will be the new norm.
The good thing for investors is that there are “thematic” ETFs that follow these trends, current and upcoming.
For example, there are cyber security ETFs available to purchase on the stock market. If you’re certain cyber security is going to be big in the near future, you could hold some of these.
For firm believers in eCommerce, there are also ETFs tracking particular eCommerce brands of interest. And you could’ve guessed it, but Alibaba is one of the more popular stocks tracked by eCommerce ETFs.
Above are just some examples of ETFs that ride on the new smart economy trend. Retail investors who see other up and coming niches in the world that are not discovered and picked up by the mainstream market yet would eye the more obscure ETFs.
3. Balance your portfolio with several ETFs
As much as ETFs are great for diversification and minimising risk, a retail investor’s portfolio must be balanced. There should be more than one ETF in a retail investor’s portfolio. It’s the same as a regular portfolio of stocks.
Having only one ETF in the portfolio is almost as good as having just one stock. For example, if you allocate your entire portfolio to buying the STI ETF, you will run into a huge problem if the Singapore stock market crashes.
Another tip Alvin mentioned was to have a variety of ETF types. That means we should not just have thematic ETFs or just major index ETFs our portfolios, although the latter might work decently well.
Thematic ETFs are generally more risky and uncertain than major index ETFs because the former is based on trends, which might not always be the most accurate gauge of the general market sentiment.
Nevertheless, the proportion of each ETF depends largely on each retail investor’s risk appetite and investment horizon.
- How To Invest Using Exchange Traded Funds (ETF) For Portfolio Diversification
- Comprehensive Guide to STI ETF
Alvin also briefly touched on factor-based investing, a strategy he recently devised after spending hours on books and research done by the world economists and professors.
The overall idea of factor-based investing is to diversify not only in a range of securities, sectors and countries but also a range of investing factors. Some examples include value versus growth, small caps versus blue chips, lower volatility versus higher volatility and so on.
Alvin will talk about his newly discovered approach at our upcoming Shares Investment Convention on 16 September 2017 (Saturday), where you can learn how to invest like the pros – people like Alvin, David Kuo from Motley Fool Singapore, Rusmin Ang from Fifth Person and Kim Iskyan from Stansberry Churchouse Research.
These experts bring decades of their experience in the stock markets, weathering the financial crises that spooked retail and institutional investors alike.
Alvin will share how you can really profit from the markets today with factor-based investing. Be sure to grab your tickets now by clicking here or on the button below. See you there!