Outperform Markets with Exchange-Traded Funds
When you compare the average performance of individual investors over a 10 year period against the performance of the markets, very few investors outperform the market. That does not mean you can buy into index funds which track the markets and forget about your investment until you retire. With dwindling market returns and ever increasing inflation and healthcare premiums, not to mention long term care, an expected decline in real estate values and vanishing employer paid retirement benefits, what you need is an investment which consistently outperforms and beats the market in every quarter. This is where Exchange-Traded Funds, or ETFs, come in to the picture. ETFs are basically indexed mutual funds which trade like stocks and offer low transaction expenses, portfolio diversification and tax efficiency.
As with stocks, the question of which ETF will beat the market remains a strategic question for investors, which must be answered with information, knowledge of market trends and sectors and more importantly, some common sense. Investing in to ETFs is much like value investing. What happens is that with the purchase of one exchange-traded fund, you buy a stake in numerous businesses. To be able to beat the market you have to make a judgment call, and decide which sector the market is undervaluing, and buy into it. As the market corrects itself, and reflects the true worth, or real value, of the companies, your investment in the ETF gains value.
A simple way to achieve this would be to buy ETFs in a sector which has recently been hit by a bear run, such as financials or the housing sector, both of which are being buffeted by waves of subprime mortgage write-offs. Investments in both sectors are at a historic low, and the situation is expected to continue will into 2008 and maybe even 2009. Consequently, if you purchase ETFs today in either financials or the housing sector, your ETFs will be trading vastly higher come 2010, or 2011.
Now, this may sound simple, but there are a lot of complications and things you need to know before you can start investing. For starters, if the underlying companies in the ETF are not sound, then no market swing is going to help you outperform. So, here’s what you need to do. Before you enter the game, pick up an ETF you like, and study each company in the ETF. Takes time, and a lot of effort to rate individual companies within exchange-traded funds, but that’s what you have to do. Trusting someone is not an option. There are, however, research tools and online data providers who are willing to do the hard work for you, and provide you with their analysis, including detailed charts, historical data and comprehensive explanations for their conclusions.
In summary, first you have to decide which sector is trading below its net intrinsic worth. Secondly, once you have identified a likely ETF, you need to take it apart, and study each company, one by one. Study their P/E ratios, cash values and historical performance. If a maximum of these companies are individually trading below their margin of safety, then you have a safe bet. The sector is down, individual companies are down and both are likely to go up in the near future. Unlike stocks, the associated risk is very much reduced, since individual companies tanking might reduce performance a bit, but won’t wipe out your investment. Thus, what make exchange-traded funds so attractive are the low expense ratios, relatively lower risk and better chance of outperforming the markets. Please note that some ETFs may not have the same low expense ratios and high performance qualities normally associated with them. You are advised to do your own research and consult with your financial planner or stock broker.