Elm3’s Guide to Exchange-Traded Funds (ETFs)

By: Stacey Nickens

As investors, we are always inundated with reminders to diversify our portfolios. Diversification involves adding lots of companies to your portfolio, such that your portfolio is exposed to a variety of company sizes, company styles, and sectors. Diversifying your portfolio helps create stability. If one company or one sector experiences market volatility, the other companies and sectors within your portfolio can protect your portfolio from some of the losses experienced by the volatile security.

However, diversifying your portfolio can be challenging if you do not know which companies to add or if you have fewer dollars to invest. For example, with only a few thousand dollars, you cannot afford to buy individual securities that represent a sizable portion of the stock market. So how do you diversify your portfolio?

Investors can use exchange-traded funds, or ETFs, to provide diversity to their portfolio. ETFs hold dozens or hundreds of companies. The purchase of just one ETF share can provide your portfolio with significant diversification benefits.

ETFs trade like stocks, with their per-share price fluctuating throughout the day. Unlike open-end mutual funds, ETFs do not have a Net Asset Value (NAV) calculated at the end of the trading day. The price of the ETF is determined by the market, and you will know the price of the ETF share when you’re purchasing it, instead of having to wait until the end of the trading day.

ETFs also tend to be passively managed, meaning that portfolio managers aren’t regularly conducting trades and generating trade fees within the fund. For that reason, ETFs tend to have lower expense ratios than actively-managed funds, such as open-end mutual funds.

Finally, ETFs have an investment goal, allowing you to select ETFs that align with your own investment objectives. Some ETFs track stock market indexes. Other ETFs hold companies in specific sectors or companies of a specific style. For example, the Vanguard Mid-Cap Value Index Fund ETF (VOE) holds mid-cap value companies, as the name would suggest. ETFs might also have income or growth goals, holding companies that pay strong dividends or have strong growth prospects.

In this current market environment, I am watching ETFs that track value companies, pay strong dividends, and invest in defensive sectors. Undervalued companies can outperform during volatile market moments. Investors see market drops as an opportunity to invest in companies that are trading below their book value. Investors then hope that, as the market recovers, these companies will begin to trade in-line or above their book value, allowing the investor to experience gains. Dividends also offer stability during volatile market moments, as they are often paid regardless of the broader economy. Finally, with recessionary fears in the air, investing in defensive sectors can be prudent, as defensive sectors include companies whose revenues are less impacted when households cut spending. Defensive sectors include consumer staples and utilities.

Here are three ETFs I am watching that fit these criteria:

• SDPR S&P 600 Small Cap Value ETF (SLYV): SLYV exposes you to over 400 undervalued companies, including Hostess Brands and BankUnited. Companies within this ETF are considered undervalued because they have low book value-to-price ratios, low earnings-to-price ratios, and low sales-to-price ratios. These low metrics suggest that these companies’ stocks should be worth more, given their earnings and book values. Over the long-term, companies’ stock prices tend to perform in-line with their underlying value, and accordingly, companies within the SLYV ETF are likely to experience growth as their stock prices rise to meet their actual earnings and sales. Undervalued companies also tend to experience less volatility than the broader market, with the SLYV ETF down 9.15% as of close on July 27, while the S&P 500 was down 15.58% as of close on the same day. Finally, SLYV offers a forward dividend yield of nearly 2%.
• Schwab US Dividend Equity ETF (SCHD): The SCHD ETF focuses on income, as its name would suggest. The ETF holds high-quality, dividend-paying stocks, such as Pepsi, Pfizer, and Home Depot. With the dividends offered by the ETF’s 104 holdings, SCHD offers a forward dividend yield of 3.37%. Not only does SCHD offer income to an investor’s portfolio, it also offers a bit more stability than the broader market. Finally, investors retain much of the ETF’s dividends and growth, as the fund has a very low expense ratio of only 0.06%.
• Fidelity MSCI Consumer Staples Index ETF (FSTA): With a recession potentially on the horizon, investing in defensive sectors can offer your portfolio a hedge against company income loss. Defensive sectors include consumer staples and utilities, as consumers must purchase staples and utilities, regardless of the broader economy’s performance. The FSTA ETF gives you strong exposure to the consumer staples sector, offering you exposure to such companies as Walmart, Procter & Gamble, and Colgate. Moreover, the ETF pays a forward dividend yield of 2.33%.

As you make decisions about diversifying your portfolio, I encourage you to reach out to our experienced investment advisory team for support. We can help you achieve your savings goals.