This article originated from my blog: Investing Beanstock

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Now that you understand the basics of investing: To hold long term and to keep on contributing either through a lump sum method or Dollar Cost Averaging method, and understanding the importance of compound interest and why it is important to buy assets, you now ponder, “Which ETFs should I pick so that I maximise my long-term returns potential?”

So how exactly should you go about picking market-beating and high risk-adjusted returns potential ETFs that complements your existing portfolio or to build up your investment portfolio?

Understanding the basics of ETFs

Exchange Traded Funds, or ETFs in short, is a form of wrapper fund which works like a Unit Trust/Mutual Fund. Each individual ETF holds a basket of stocks and are benchmarked against a certain index.

ETFs are highly favoured by retail investors and hedge fund managers alike due to their high liquidity, meaning its easy to buy and sell out of the ETF position, something which you won’t have if you buy Mutual Funds instead. (which are more illiquid and have bad bid-offer spreads)

So why invest into an ETF? Because they are diversified in nature as it is holding a basket of stocks. Instead of holding just 1 single stock like Apple or Google, by owning one ETF such as VOO (Vanguard S&P 500 ETF), you own the top 500 US companies (by market cap) automatically.

One thing to note is that there are many types of ETFs out there, and not all ETFs are suitable for long term buy-hold strategies.

Different Types of ETFs

To keep it simple, I will list down some common ETF types are how they can help investors/traders with their own agenda:

1. Index ETFs (tracks an index eg. S&P 500, aims to match market returns the benchmarked index)

2. Thematic ETFs (focuses on specific themes eg. Cloud Computing, specifically for targeted investments for potentially higher returns)

3. Inverse ETFs (used by mostly traders/hedge funds to short against a specific index, i.e if the market crashes, the ETF will in turn gain)

4. Sector ETFs (similar to thematic ETFs, but instead of themes, they target sectors such as Technology, Utilities or Healthcare)

Expense Ratios

Now that you understand the different types of ETFs out there, we now go to the specifics of an ETF.

Expense ratio in simple terms, is the fees you pay annually to the ETF provider, just like how you pay management fees to a fund manager or Robo-advisor.

Why is expense ratio significant? Because the higher the expense ratio, the more it eat into returns in the long run.

Most ETFs have expense ratio which are much cheaper than Unit Trusts/Mutual Funds due to the passive nature of most ETFs, which makes them more attractive cost-wise as a long-term passive investing vehicle.

Typical Expense Ratio:

ETFs: 0.03%-0.75%

Unit Trusts/Mutual Funds: 1%-3% (excluding performance fees)

With an expense ratio of 1%, that means for a hypothetical amount of $10,000 invested, you are paying $100 in fees annually, compared to an expense ratio of 0.03% where you are only paying $3 in fees annually.

Examples and hypothesis aside, why do some ETFs have such high expense ratios?

Active Management vs Passive Management

The difference in expense ratio is due to how involved the investment team is when it comes to managing the ETF.

Index ETFs

Index ETFs such as S&P 500 Index ETFs such as VOO/SPY/IVV/CSPX are passively managed because they merely track the underlying index based on its market cap, and does not require constant trading in and out of positions when compared to a active ETF. Index based ETFs typically have an expense ratio of between 0.03%-0.5%.

Remember, for passively managed Index ETFs, the lower the expense ratio the better because it eats less into your returns in the long run and ensures market return. (before fees)

Index ETFs are great as a starting investment and to build up as part of your core portfolio as it allows the beginner investor to be diversified and get close to market returns (after fees) for the long run. Typically, index ETFs have a long term annualised return of between 7%-10%, depending on the index tracked and the underlying fund’s investment thesis.

Some great index ETFs within my portfolio are the following:

1. Invesco QQQ Trust (tracks the NASDAQ-100 Composite Index)

2. iShares Core S&P 500 UCITS ETF (tracks the S&P 500 Index)

3. iShares MSCI EAFE ETF (tracks the MSCI EAFE Index)

I gained exposure into these ETFs using the Syfe Equity100 portfolio. You can read up more about it here.

Thematic ETFs

Thematic ETFs focuses on finding themes which will be poised to grow much faster than the rest of the market and usually forms a small part of an overall portfolio due to the higher volatility of such ETFs. They can be useful as to form satellite portfolios.

They are typically actively traded and managed by an expert team of stock analyst which aims to find disruptive technology and future innovation trends from the current market, such as Cloud Computing, Artificial Intelligence, Clean Energy, Genomics Revolution, Internet of Things and more.

Such ETFs commends much higher returns but also higher amounts of risk and higher expense ratios, typically in the range of 0.6%-0.75%. However, if holding such an ETF with a long term annualised return of 20% or even more, the expense ratio is justifiable because you are paying more for the market outperformance.

Being able to find an ETF which can deliver more than 10% annualised over the long run is extremely important so make sure you find 1 which aligns with your own beliefs about the future.

Some great ETFs in this category under my portfolio are:

1. ARK Innovation ETF

2. ARK Next Generation Internet ETF

3. ARK Fintech ETF

Of the ETFS here, they have returned a total of more than +40% returns this year and from 2021 onwards, I hope to contribute even more into these positions as I am highly convinced of the research team and investment thesis.

Inverse ETFs

Inverse ETFs such as SQQQ aims to bet against the index, in this case, to bet (or short) against the NASDAQ-100 Composite Index, which consist of mainly tech companies.

If you are a trader who is bearish on the market and wishes to earn money while the market declines, inverse ETFs can be a useful tool because instead of shorting on 1 single stock, you short the entire market which may or may not be a good idea depending on how you are going to play it.

Word of caution: If you are a newbie and have not traded before, I suggest you to avoid inverse ETFs because they are extremely complicated and difficult to understand for most layman, things such as time decay, derivatives collaterals and more may make inverse ETFs unsuitable for many, as they are mainly used for hedging purposes and not for long term passive buy-and-hold investors.

Sector ETFs

These ETFs basically are the narrowed down version of index ETFs as they focus on specific sectors within an index, or specific sectors within the economy. For example, if you really like the tech and healthcare sector, you can buy into tech and healthcare sector ETFs to expose yourself more to these sectors.

Typically, sector ETFs are used as satellites which are meant to boost overall returns of the core portfolio by a few % points and will be rotated in and out of the portfolio depending on the state of the economy and future trends.

These ETFs typically have expense ratio between 0.2%-0.6% or even more depending on the ETF manager.

Some sector ETFs which I am exposed to under my Syfe Equity100 portfolioare as such:

1. Consumer Staples Select Sector ETF (Consumer Staples stocks such as Coca Cola, P&G)

2. Healthcare Select Sector ETF (Healthcare stocks such as Pfizer, J&J)

3. Technology Select Sector ETF (Tech stocks such as Amazon, Facebook)

How to start?

Now that you understand the different ETFs offered and their functions, you now need a place to buy them. For these ETFs, most of them are found on the US stock exchanges such as NYSE/NASDAQ and the most cost efficient and easiest way to begin is to start with an US-based broker such as the one I use: Firstrade

You can read up more about Firstrade and opening of the account here.

If you already read about Firstrade, then click on this link here to sign up!

After creating the account, you simply need to add the tickers to your watchlist and either lump sum invest or slowly Dollar Cost Average (DCA) and buy a few shares every month.

You can even opt to buy more or buy less which is highly flexible but you need to keep buying for DCA to be effective. I personally use Firstrade to buy ARKK/ARKW/ARKF and more ETFs.

Alternatively, you can get instant diversifications across 12 different ETFs using Syfe Equity100 Portfolio, which uses a factor-based investing approach for long term investing. I personally started the Equity100 portfolio in July and extremely happy with the returns thus far. You can see the returns and fees and more updates here.

Syfe Promo Code

For people who are interested to invest into Syfe and wants to open an account, you can use the promo code below as a bonus!

Promo Code: SRPTH8LK3

$10 bonus for the first deposit of $500 (or more)!

$50 bonus for the first deposit of $10,000 (or more)!

$100 bonus for the first deposit to $20,000 (or more)!

Note: Bonus is applicable on the first deposit made only. The bonus will be automatically credited to your portfolio and invested along with your existing investments

Conclusion

At the end of the day, choosing the right ETF may seem daunting as there are thousands of ETFs out there. Just which one is the best for the long run?

The plan is simple, set up your own portfolio by allocating a core fund and a satellite fund. Your core fund will consist of ETFs which you absolutely will hold for the long run without ever selling them. Such would be index ETFs and some thematic ETFs which you strongly believe in.

A few core ETFs you can look into are:

1. VOO (Vanguard S&P 500 ETF)

2. VTI (Vanguard Total Stock Market ETF)

3. VT (Vanguard World Stock ETF)

4. QQQ (Invesco QQQ Trust)

As for satellite portfolio, you can allocate some fund for higher risk higher returns type ETFs and a few you can look into are:

1. SOXX (Semiconductor ETF)

2. ARK ETFs

3. XBI (Biotech ETF)

4. XLK (Tech Sector ETF)

5. WCLD (Cloud Computing ETF)

Let me know which ETFs you are invested in or which ones you are most interested in in the comments below. Would love to hear your thoughts! Cheers and happy investing! (And Merry Christmas and Happy New Year!! 🤩)