Exchange traded funds (ETFs) are mini mutual funds that can help you invest in a sector of the stock market and pay a lower management fee than many mutual funds charge.
ETFs are made up of a group of stocks in a particular sector, such as gold, oil, a foreign country and so on. Since the ETF has a number of companies, it more or less mellows out returns but it also reduces risk. Most ETFs will end up with winners and losers or at least big winners and little winners, so an ETF will not likely be that 10 banger stock many investors hope for.
However, since an ETF will hold stocks in several companies, you also reduce what is called corporate risk — the risk that a company will do something stupid or run into problems while you own the stock. A lot of ETFs are born during bull markets in a sector when money is flowing towards stocks in a sector and some investors don’t want to pick and choose one or two companies to buy shares in. In response, money managers set up an ETF to fit the demand.
At this time we can buy an ETF on gold (GLD) or ag companies (COW), banks, foreign countries such Indonesia and China, and so on.
Some ETFs also let us sell covered calls on them, which could boost gains if done right or maybe limit our gains if done wrongly. I will give you a list of ETFs that I have found, but I have to say I personally do not own any ETFs. I just like to own shares in individual companies and I like to sell covered calls on them. That is my personal methodology and I see no reason to change it at this time.
However, if you’re too busy to find and track individual stocks, or if you want to reduce the corporate risk and perhaps lower management fees, than maybe ETFs can be part of your portfolio.
Most mutual funds charge a management fee. That’s what pays the people, the light bill and so on. I don’t own any mutual funds but as I understand it, the fees run something around 2.5 per cent per year, but they could be higher and lower. Also some fees are charged at the front end, some are charged ongoing and some are charged at the back end.
In any case, most mutual funds have people, offices, travel and so on. So costs add up. With ETFs, the managers just allocate a certain percentage of money to one stock, another percentage to another and so on and generally rely on the exchanges to provide information. So fees often run at less than one per cent per year.
One ETF (GLD) is set up to own gold. So if we buy some shares or units in GLD, the managers buy gold with the money. If we sell some units or shares, the managers sell gold accordingly.
ETFS PRO VIDE SAFETY IN NUMBERS
A lot of people think there’s safety in numbers, so they own 20, 30 or 50 stocks. If you can think on that many stocks, fair enough. I can’t. I own maybe 12 stocks in several sectors. I do take steps to lower corporate risk because we own two gold stocks (AEM and YRI) and three oil stocks (IMO, PBG and SU). We own opposing stocks such as CNR, which I think is an opposite to oil, and we own CCO, which is an energy stock in a way but not oil or natural gas.
Plus we own a couple techies, mainly Apple and Rim and Shaw, as well as Fortis, Agrium, Potash Corp and Intrepid. And I just sell calls on all of them month after month after month.
However, I am getting to know those stocks and I do understand I carry some corporate risk. We likely could own maybe three ETFs and cover most of those same sectors.
By the way, as of the end of January, our accounts were up three to six per cent for the year to date, while the general market was down about eight to nine per cent. The accounts that were fully invested in stock were up near six per cent and the accounts with 40 per cent cash were up around 3.1 per cent. This mostly was because we sold covered calls on most of our stocks and then Agnico Eagle (AEM) was up over 50% and we had managed the options so we did not limit gains. Plus when Steve Jobs of Apple went on sick leave I felt money was going to leave Apple and start to buy Rim so I bought Rim at around $60 and now the price is pushing $70. And shares of Apple have not dropped. So in spite of a poor start in the overall market our strategy is bringing in the cash. Plus we keep the dividends when we sell covered calls.
I think we need to own some gold investments and there are two popular gold ETFs, GLD on the U. S. side and XGD on the Canadian side. Both have an option. For example, we could sell a covered call on XGD for March for $21 strike price and pick up 50 cents. If we could do that six times a year we’d have $3 per unit, or around 14 per cent return per year. We could cut it finer and sell the March $20 and collect around $1 and if we could do that 12 times a year, the return would be over 50 per cent.
The reality likely would be somewhere in between but remember we would not be taking on corporate risk because we’d own a basket of gold stocks.
If you want to own ag stocks or an ETF for ag stocks, there are several. On Montreal Exchange you can find COW and on MSN you can find MOO. Again both have options so we can sell covered calls on them. There’s another ETF that just carries grain commodities.
FOREIGN COUNTRY ETFS
I likely would never buy these but if you have a hankering for investing in other countries, you have several ETFs to look at. For example, the ETF for Asia including Japan is IFAS and Asia without Japan is AAXJ.
You can buy an ETF for financials (XLF), which is testing new lows. TIP is an inflation protected bond fund. XFN is a Canadian financial ETF.
On the energy side, there’s XEG on the Montreal Exchange, and UNG natural gas fund in the U. S.
As I said, I don’t follow or own these, but if you put them on a chart with the MACD and owned them as the MACD was rising, well a person likely could do worse. And if you learn how to sell covered calls, odds are you can boost total returns but this is a skill few people know how to use properly. I teach this stuff in StocksTalk and I sell covered calls on all of my stocks.
The premiums paid on covered calls on ETFs usually are smaller than for stocks and that’s because ETFs are less volatile (don’t move up and down as much as stocks). But done properly, selling covered calls on ETFs can still beat the returns one would expect from just holding an ETF.
ETFs trade like stocks, and investing in them is a reversible decision. In other words, you can sell if you feel you’ve made a mistake or want to invest somewhere else. Some are more liquid than others, but they do trade on public markets.
UPDATE ON TFSA
Since my last article on the TFSA, brokers and banks have announced the fees they plan to charge. Almost overnight the general media has turned cold on TFSAs because the fees appear to be eating up all the money the $5,000 could earn if a person buys a normal money market investment.
Some brokers say they will not charge a fee, but others will charge $50 for set up, some will charge for moving money around and so on.
I personally have not gotten around to setting up our TFSA, but I will. Many readers of StocksTalk have already done so. For us, the most popular strategy appears to be to buy 200 shares of a company like Cameco (CCO) and to sell covered calls on them. Some readers bought 200 shares of Fortis (FTS), some bought Kinross (K) and I think some even bought 100 shares of CNR. And all sold covered calls on those stocks and picked up from $120 to $200 for the month of February. I would expect they can do that 10 to 12 times a year.
Plus some of those stocks pay a nice dividend, which stays in the TFSA. From what I can see, if a person is going to earn two per cent on the $5,000, then setting up a TFSA might not make much sense. Putting that $5,000 into an RRSP might make more sense because at least a person would reduce taxes or get a tax refund.
AS GOES JANUARY
We just finished the month of January and stocks in general are down 9.7 per cent for the month. Jory Capital’s Amel says that since 1950, as goes January so goes the year. Since January 2009 is the worst January on record, we have to be very careful if we own stocks.
Andy lives in Winnipeg. He runs a small tax business, manages his own investments and publishes a newsletter called StocksTalk where he explains in detail what he does with his investments. If you’d like to read it free for a month send an email to [email protected]