ETF's (Part Three)

I am doing a follow up to ETF’s (Part One) and (Part Two) this week. I’m taking a deeper dive into what makes up an ETF and how exactly they work. To recap the earlier posts, ETF’s (Exchange Traded Funds) are like a mutual fund but trade like a stock. They can be made up of a variety of different securities. Its main advantage over a mutual fund is the management and administrative fees are much cheaper. Now that we have the background from the previous two posts, we are now ready to figure out exactly what an example ETF is composed of and what information is relevant before buying one from a broker or discount brokerage.

For example purposes, I have chosen the Vanguard S&P 500 ETF (ticker symbol VOO). Vanguard is an investment management corporation. I chose this ETF because it is an index ETF that tracks the S&P 500. There are many other index ETF but I chose this as an example (I do not own this ETF nor am I affiliated in any way with Vanguard) and I can buy it through my Questrade account. Here is a screen shot of this ETF from the Vanguard website:

 Courtesy of the Vanguard website

Courtesy of the Vanguard website

As noted on this sheet, the goal of this ETF is to track the return of the S&P 500 which as we learned previously, represents 500 of the largest US companies. The S&P 500 is, as stated, considered a gauge of overall US stock returns. This particular ETF is considered a growth ETF by Vanguard. This type of ETF is more appropriate for long-term goals such as growing your money  (as opposed to an ETF that is not as focused on long term growth but rather  a slow, steady and predictable place for your money).

Other points to note about this particular ETF as taken from the relevant Vanguard online info sheet include: 

·      Its expense ratio of 0.04% is 96% lower than the average expense ratio of funds with similar holdings (this is Vanguard's statistic). This means that if you invested $10,000 in the ETF, you would pay $40 per year to have the fund managed. Although you are well advised to get into the fine print as to how exactly this would be charged and on what amounts, etc. as it may not be as simple as this calculation;

·      Vanguard Equity Index Group is the advisor of this ETF;

·      The risk potential is rather high at 4 out 5. You could research a lower risk ETF if that was more in line with your investment goals;

·      The market price of this ETF is $243.84 USD – This is the cost of one share of this ETF. So, if you wanted to invest $5,000, you would be able to buy $5,000/$243.84USD or 20.5 shares;

·      The NAV is $243.88. NAV is the Net Asset Value of the ETF and is an important metric used to gauge the market price of the ETF. What does this mean? First off, the NAV of the ETF is the total of all of its assets (the value of the bundle of securities (cash, stocks, bonds, commodities, etc.) less any liabilities and then divided by the number of shares outstanding. The number resulting gives you an idea of what is the fair value of a share of the ETF. This then provides a reference point to compare to what you are paying for the market price for one of the shares of the ETF. Are you paying a lot more? A lot less? How do the two numbers compare? In reality, the market price will be close to the NAV but it is still nonetheless a good metric for comparison.

·      Building on the above, the Premium/Discount line item indicates whether the ETF is trading at a premium to the NAV (ie. the market price is higher than the NAV) or a discount (ie. the market price is lower than the NAV).

·      The other tabs on this page tell you more information like the returns over the past few years and you can see how the returns of this ETF compare to other comparable ETF’s and the S&P 500.

·      The Portfolio and Management Tab also has a wealth of information about this ETF. In particular:

o   This ETF is a large cap blend. It is a blend of value and growth large cap stocks.

o   It contains 507 different stocks within the bundle and the ETF has a P/E of 22.5. This is a little on the high side but this ETF is a higher risk ETF and a blend of value and growth stocks. Review How Do I Evaluate a Stock? (Part One) for more information to learn about the P/E ratio.

o   The tab also indicates how the ETF is broken down in terms of which industries the stock holdings are based. As you can see, the majority of the stocks are in the information technology sector at 24.50% of the ETF. The next two highest are financials and health care. This ETF, true to its intention, tracks the S&P 500 exactly in terms of its stock make up.

o   Further down in this tab, you can then see what the ten largest holdings in the ETF. In this particular ETF, Apple Inc. is the largest holding, followed by Microsoft and then Alphabet Inc., etc. You could see all 507 stocks in you desired by following up with likely with the manager of the ETF.

·      This ETF pays a dividend and you can gather this information from the Distributions Tab. The dividend on an ETF works by collecting all of the dividends from all the underlying stocks in the bundle and paying it out to you, a shareholder. It can come to you as cash or to be reinvested into the ETF in which case you get more units of the ETF. This ETF pays you about $1.18 every quarter or $4.72 over the year so if you had invested $5,000 in this ETF, you would own $5,000/$243 or 20.5 units as outlined above and that would net you 20.5 * $4.72 = $97 of dividend income per year. This amount could become quite substantial if you owned a significant amount of this ETF.

·      The realized and unrealized capital gain or loss amounts are listed also on the Distributions Tab. Realized capital gain amounts are gains realized by the ETF by actually selling of certain underlying securities. You will pay tax on capital gains (see ETF's (Part Two)). Realized capital losses are losses actually realized by the ETF through sale of underlying securities. Unrealized gains and losses are “on paper” as the sale hasn’t happened yet but you may be on the hook to pay taxes on these if you invest in the ETF. Vanguard provides helpful information as to how mutual funds and ETF’s are taxed here. I would also recommend reading the attached Vanguard document about best practices for trading ETF’s as it provides many helpful tips.

Analyzing this ETF has gotten us closer to understanding exactly how an ETF operates. I am going to purchase this ETF on Questrade using the trial account and will see how it performs.

**Top photo courtesy of Dom J at Pexels photos