Recently I’ve been looking at my asset allocation and thought it would be a good opportunity to talk about exchange traded funds (ETFs). Just like common stocks, ETFs are traded on exchanges and allow you to invest in funds managed by professional fund managers which have a predetermined investment mandate and benchmark. Unless you have above average stock picking skills and you have been regularly generating alpha, my advice is to invest a sizeable part of your portfolio in a passive portfolio that tracks the market. In my case, I hold a long term positive view on the growth of the American economy, so over the years I have been stashing a considerable chunk of my savings in an ETF tracking the S&P500. The remainder of my portfolio is invested in ETFs tracking EMEA blue chip stocks, emerging markets, the global fixed income market, gold and real estate.
My Financial Situation and Some Tips before you Start Investing
Before you even start considering investing in the stock market, make sure you are meeting more crucial needs which I identify as the following:
– Paying off any credit card debt. This is self-explanatory, every bit of interest that is accruing is eroding your returns. Ensure to pay any credit card debt before investing.
– Budgeting your monthly expenses and keep a safety reserve of cash so that if you lose your job or come across some unforeseen events you are prepared.
– Checking if there are better ways in which you could use your money. Investing in yourself via qualification and courses might increase your earning potential and overall provide a higher future stream of cash flows.
– Investing in your health. Your health is also an extremely valuable asset so don’t neglect it.
– Paying attention to the cognitive part of your investment process. If you do decide to invest, make sure you are investing amounts of money that you are comfortable losing. Yes the economy has been in a long bull market but the odds are that eventually it will crash and you could see your portfolio take a huge hit. In such cases, you don’t want to be stressed out and liquidate your portfolio at suboptimal times. You need to be able to withstand such events from a mental and financial perspective and keep a mindset that invests for the long run. You need the discipline to research and implement a plan and to stick to it.
As for me, I am in my 30s, in good health and my investment goal is to build my retirement portfolio giving me a long investment time horizon. I have put aside an emergency fund so all the money that I am investing I can afford to keep invested for years and years to come. I have decided not to buy a house so I am mortgage free at the moment and my main source of income comes from my full-time job. When looking at a very basic asset allocation between risky assets such as equities and safer fixed income instruments the rule of thumb is to take 100 minus your age, this would result in a 65% to 70% allocation in equities for my portfolio. In my portfolio I have included alternative investments such as real estate and commodities as it has been empirically shown that their low correlation with traditional assets enhance portfolio risk adjusted returns.
If I were to summarise the investment process
– Identify your investment goal(s)
– Assess your current financial situation.
– Execute the plan in a cost-efficient manner (this involves looking for best execution)
– Monitor your plan and check and develop a feedback loop.
Pick the right ETF
Once you have done your research and you have developed your investment mandate in accordance to your goals and views it’s time to start screening for ETFs. Companies like Morningstar provide a rating for ETFs and a lot of brokers give a ranking of popular indices based on trading volume which should help you familiarise yourself with the most popular ETFs. Having said this, it’s always best to perform your independent research rather than relying strictly on popularity and reputation. Once you’ve found an ETF that you are interested in, ensure that you read the prospectus. Have a look at what the index performance has been (although by all means these will not guarantee future performance). Look at the volatility to see if the asset satisfies your risk appetite. The below link is an example for (VOO), Vanguard 500 Index Fund ETF Shares.
Also pay close attention to the investment fees that the ETF is charging, for a passive strategy that tracks the market you want to ensure that you are minimising your fees so that they do not erode your returns. If you are looking at an active strategy that has the potential to generate alpha then you can start considering paying higher fees.
You should also check historical payment of dividends and see what yield the index is generating, such dividends are far from being negligible and constitute a core part of your total return. You can also opt for total return indices where dividends are automatically re-invested rather than being paid out.
US stocks are overpriced now and when should I invest?
As I am writing this post, 15 July saw a new record high of the S&P when it closed at 3014, understandably a lot of investors are reluctant to put in more money. Faced with this situation I believe there are two choices, the first is to spend a lot of hours trying to attempt to time the market. Needless to say, this is extremely hard. Another option, which is the one that I recommend, is to apply a cost averaging method where you gradually invest at different market prices at different times. Don’t invest any money that you cannot afford to invest and give your investments time to grow and to compound in the long run.