Markets

Look for the Best Core Index ETFs in Your Own Backyard

One of the biggest benefits to incorporating ETFs in your portfolio is the capability of these funds to provide instant exposure to a particular market segment with built-in diversification. Too often this simple facet goes overlooked as the analysis of enhanced indexes, fees, tax considerations, and liquidity overwhelm our senses.

While these characteristics are important, they often provide additional noise that can drown out the sound principles of index investing. i.e. Owning a well-diversified mix of assets to smooth out volatility and enhance long-term returns.

According to the fund screener at ETF.com, there are nearly 1,700 exchange-traded products currently available to U.S.-based investors. That is a tremendous menu of options that make for incredible flexibility and unfortunately an array of pitfalls when trying to discern the best fund to meet your needs.

When it comes to constructing the core of your ETF portfolio, the number one thing you should focus on is simplicity. The fact is, many ETFs provide very similar exposure with minute index variations that may only be applicable in an academic rather than real-world sense. Case in point is the two largest ETFs - the SPDR S&P 500 ETF (SPY) and iShares Core S&P 500 ETF (IVV). Both provide access to the same underlying stocks, with the same market cap weighting, and trade millions of shares per day.

So how do you decide which one to own?

For some it comes down to familiarity or fund family, while others will select an ETF based on its expense ratio or asset size. Nevertheless, a new dynamic is making ETF selection easier than ever for investors that want to minimize trading fees. It may well come down to which broker you have your accounts parked at.

Your First Look for Core Index ETFs

Many of the world’s largest brokerage companies such as Fidelity, Charles Schwab, and TD Ameritrade have their own suite of low-cost ETFs or a relationship with a world-class ETF provider (i.e. Blackrock or Vanguard). This allows for commission-free trading on a wide array of options along with significant reporting and research facilities to construct your portfolio.

If you have your money at one of these brokers and are searching for a large-cap growth ETF, why spend hours poring over the countless options when you can narrow the search to 1 or 2 transaction-free funds? You will likely find a choice in this category with an expense ratio of less than 0.15% that you can own with no additional barriers. It’s that easy.

Agonizing over the differences between the Schwab U.S. Large-Cap Growth ETF (SCHG) versus the Vanguard Growth ETF (VUG) will drive you crazy and likely only contribute to miniscule differences in total return. The more important concept for ETF investors is having the correct structural exposure rather than overwhelming conviction in index methodology or fund family.

In addition, these transaction-free ETFs allow you to add small amounts at any frequency you desire without incurring the penalty of a trading commission. This is a highly desirable characteristic for those that are saving for retirement, dollar cost averaging, or breaking up their trades into multiple orders.

Expanding Beyond Core Strategies

These passively managed ETFs make perfect vehicles for core strategies, but many investors may also want to supplement those holdings with fundamental or strategic positions. There is certainly room for enhancing a particular corner of your portfolio towards a specific theme with the expectation of greater returns.

It should be anticipated that more niche ETFs focused on industries or smart beta strategies will incur a higher overall expense ratio and may be susceptible to standard trading fees as well. In that instance, it makes sense to closely analyze the underlying characteristics of each fund versus its peer group. There are often times widely varying differences in the makeup of each ETF along with expenses, portfolio turnover, and historical performance.

Disclosure: At the time this article was published, clients of FMD Capital Management owned VUG.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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ETFs Investing Retirement