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What is an ETF?

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What is an ETF?

What is an ETF?

In 1989, the idea for the exchange-traded fund (ETF) was born.

Initially marketed to investors as Index Participation Shares, this innovative new product was meant to be a proxy for the S&P 500 that also traded on an exchange like a stock. After being launched, this early ETF prototype was immediately targeted by lawyers of the Chicago Mercantile Exchange (CME) for illegally behaving like a futures contract. A lawsuit ensued, and a federal judge in Chicago ruled that they needed to be withdrawn.

A year later, the case can be made that Canada was the birthplace of the first successful ETF. This time the product was called Toronto 35 Index Participation Units (TIPs 35), and it tracked the TSE-35 Index at the time. TIPs were instantly lauded for providing low-cost exposure to Canadian equities – and shortly after, many more ETFs in Canada and the United States would follow suit, including the SPDR S&P 500 Trust ETF in 1993.

How do ETFs work?

Today’s infographic from StocksToTrade.com highlights the basics around ETFs, including how they work, what type of assets they can track, and the pros and cons associated with investing in them.

In the most basic sense, an ETF is a type of fund that owns assets – like stocks, commodities, or futures – but has its ownership divided into shares that trade on stock exchanges.

In other words, investors can buy and sell ETFs whenever they want during trading hours. Like a stock, each ETF has a ticker symbol and a price that changes in real-time. However, unlike a stock, the number of shares outstanding can change daily based on the share creation and redemption mechanisms.

Pros and Cons

There are many views out there on ETFs, but it is generally accepted that they provide an inexpensive, transparent, and convenient way to get access to many different asset classes. This makes it easy to diversify a portfolio, and it also makes ETFs simple to buy and sell.

For these reasons, the passive management investment industry has taken off, and the ETF industry now has over $4 trillion of assets under management (AUM) globally. By the year 2021, ETFs are expected to surpass the $7 trillion mark for AUM.

Despite this growth and a wide range of benefits, ETFs do have some detractors.

Critics would be quick to point out that some ETFs are very thinly traded, providing wide bid/ask spreads and lower liquidity. Furthermore, there can also be instances where technical issues can cause a performance gap between the ETF and the index it tracks, known as tracking error.

As a final point, it’s worth mentioning that there is some counterparty risk with ETFs – for example, even if you “own” physically-backed gold through the SPDR Gold Trust (GLD), there is a chance that in extreme situations that you may not actually get to see the benefit of that gold. The counterparty risk stems from the possibility of a party failing to deliver on their promises, and is actually quite common to see with other types of assets, as well.

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Investor Education

How Equities Can Reduce Longevity Risk

With life expectancies increasing, will you outlive your savings? Learn how allocating more of your portfolio to equities may reduce longevity risk.

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Will You Outlive Your Savings?

The desire to live longer — and outrun death — is ingrained in the human spirit. The first emperor of China, Qin Shi Huang, may have even drank mercury in his quest for immortality.

Over time, advice for living longer has become more practical: eat well, get regular exercise, seek medical advice. However, as life expectancies increase, many individuals will struggle to save enough for their lengthy retirement years.

Today’s infographic comes from New York Life Investments, and it uncovers how holding a stronger equity weighting in your portfolio may help you save enough funds for your lifespan.

Longer Life Expectancies

Around the world, more people are living longer.

YearLife Expectancy at Birth, World
196052.6 years
198062.9 years
200067.7 years
201672.1 years

Despite this, many people underestimate how long they’ll live. Why?

  • They compare to older relatives.
    Approximately 25% of variation in lifespan is a product of ancestry, but it’s not the only factor that matters. Gender, lifestyle, exercise, diet, and even socioeconomic status also have a large impact. Even more importantly, breakthroughs in healthcare and technology have contributed to longer life expectancies over the last century.
  • They refer to life expectancy at birth.
    This is the most commonly quoted statistic. However, life expectancies rise as individuals age. This is because they have survived many potential causes of untimely death — including higher mortality risks often associated with childhood.

Longevity Risk

Amid the longer lifespans and inaccurate predictions, a problem is brewing.

Currently, 35% of U.S. households do not participate in any retirement savings plan. Among those who do, the median household only has $1,100 in its retirement account.

Enter longevity risk: many investors are facing the possibility that they will outlive their retirement savings.

So, what’s the solution? One strategy lies in the composition of an investor’s portfolio.

The Case for a Stronger Equity Weighting

One of the most important decisions an investor will make is their asset allocation.

As a guide, many individuals have referred to the “100-age” rule. For example, a 40-year-old would hold 60% in stocks while an 80-year-old would hold 20% in stocks.

As life expectancies rise and time horizons lengthen, a more aggressive portfolio has become increasingly important. Today, professionals suggest a rule closer to 110-age or 120-age.

There are many reasons why investors should consider holding a strong equity weighting.

  1. Equities Have Strong Long-Term Performance

    Equities deliver much higher returns than other asset classes over time. Not only do they outpace inflation by a wide margin, many also pay dividends that boost performance when reinvested.

  2. Small Yearly Withdrawals Limit Risk

    Upon retirement, an investor usually withdraws only a small percentage of their portfolio each year. This limits the downside risk of equities, even in bear markets.

  3. Earning Potential Can Balance Portfolio Risk

    Some healthy seniors are choosing to work in retirement to stay active. This means they have more earning potential, and are better equipped to recoup any losses their portfolio may experience.

  4. Time Horizons Extend Beyond Lifespan

    Many individuals, particularly affluent investors, want to pass on their wealth to their loved ones upon their death. Given the longer time horizon, the portfolio is better equipped to ride out risk and maximize returns through equities.

Higher Risk, Higher Potential Reward

Holding equities can be an exercise in psychological discipline. An investor must be able to ride out the ups and downs in the stock market.

If they can, there’s a good chance they will be rewarded. By allocating more of their portfolio to equities, investors greatly increase the odds of retiring whenever they want — with funds that will last their entire lifetime.

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Infographics

The Periodic Table of Investments

The investment universe is vast – but it’s also made up of many smaller components. See it all depicted in this nifty periodic table of investments.

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Periodic Table of Investments

The investment universe is vast, but it’s also made up of many smaller moving pieces.

For serious investors, the foundation of the discipline is to understand the properties of these individual components, and to have them work in harmony to achieve a specific portfolio goal.

To do this successfully, one must understand the breadth of asset classes, tactics, and categories of investments that exist – and to know how they relate to one another.

The Chemicals Between Us

Today’s infographic comes from Phil Huber, the Chief Investment Officer for Huber Financial Advisors, who has cleverly depicted this relationship graphically in his blog.

Similar to how the physical universe is made up of chemical elements, he sees the possibilities around portfolio management as drawing from a broad pool of investing “elements”. Combine these different elements together, and you get compounds, structures, and eventually entire funds.

The periodic table of investments created by his team denotes each type of investment, the primary and secondary strategy related to it, and a color classification:

Periodic table legend

Here are the seven objectives that the top letters on each box refer to:

Periodic table strategies

And finally, here are the colors that each block on the periodic table correspond to:

Periodic table color coding

As you can see, considerable thought has been put into the categories and classifications. However, as Phil notes, this is simply the opinion of one person and it is not intended to be a universally accurate depiction of all portfolio management wisdom that exists:

I fully expect that there are a handful of omissions, or perhaps a few areas where one might flat-out disagree with how I’ve laid things out. This was not meant to be 100% exhaustive, nor was it meant to be indicative of what one of our portfolios looks like.

Phil Huber, Chief Investment Officer

For more of the lessons that can be derived from this clever periodic table of investments, we suggest checking out the original post on Huber’s blog.

Is there anything that he missed, or that you think could be classified better?

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