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ETF One Stop Shop: If you only read one thing, read this!

There might be a bit of information overload so far as the holy grail of having sufficient passive income to sustain your Henry lifestyle is not for the faint of heart. I truly believe that if you just read one article, this should be what you internalize and the others are merely cherries on the FIRE cake. 

TLDR:

  1. ETFs are great especially if you pick a well diversified, cost effective and liquid ETF.
  2. Choosing the right ETF is very important and it should fit your investment thesis and goals – if in doubt, go for a well diversified option like
    • VTI: Vanguard Total Stock Market ETF covering the entire US Stock Market
    • VOO: Vanguard’s S&P 500 ETF tracking US’s largest companies
    • VNGA80: ETF tracking 80% portfolio in global stocks and 20% in global bonds

Why are ETFs so good and recommended?

Exchange Traded Funds (ETFs) are a financial product which tends to represent a basket of stocks (and sometimes even bonds) which are reallocated by the fund manager to maintain a percentage allocation of funds to ensure a stable portfolio.

The basket of stocks represented by an ETF provides a key advantage of diversification. Typically if we buy single ticker stocks, we face concentration risk subjected to the fortunes and failures of this one company. We can manually buy a large number of single ticker stocks to diversify our risks, but we also face the problem of selling and buying when some single ticker stocks move up or down. A well diversified ETF like the S&P500 makes it easy to access a diversified stock portfolio with a single buy/sell decision. 

Such convenience does not come for free and there tend to be some expense ratios (aka fees) involved in such ETFs. While these fees are relatively cheaper than mutual funds, it is still worth comparing expense ratios across ETFs as fees can easily eat into your gains over the years. Vanguard’s ETFs have relatively low expense ratios in the world of ETFs.

Tax implications are also important when choosing the right ETF. For example, VOO and CSPX both track the S&P 500, but VOO is a US market financial product while CSPX is a European market product. As such, VOO is subject to US withholding tax of 30% while CSPX is only subjected to 15% Irish withholding tax. Even though CSPX has a higher expense ratio than VOO, if we include the withholding tax, CSPX is actually a better buy than VOO for tracking the exact same S&P500 companies!

Lastly, ETFs are liquid as they are traded on open public markets, transparent where you can check what you are investing in at any time and flexible as they cover a myriad of products suitable for your personal investment needs.

Are there any risks involved in investing in ETFs?

Unfortunately, there are no risk free investments (except maybe US T Bills). Anybody who tells you that they have risk free investments are probably running a Ponzi scam. Having said that, the risks involved in ETFs is relatively lower than single stock risks.

The two main risks for ETFs would be the cost and tracking risks. On the cost, if you choose an ETF with low expense ratio and generally buy for the long run to accumulate positions, you should be fine. What we do not want is the active trading of ETFs, active day trading would yield more returns if we were to do it with single stock trades. 

On tracking risks, ETFs don’t always represent the basket of stocks by buying them directly. They can engage in synthetic replication via options etc. When there are market anomalies (eg. Gamestock type situations), the ETF might not be able to replicate the gains directly resulting in tracking error. Generally if you were to engage with large cap reputable ETFs, this risk is relatively minor. 

So how do we choose a suitable ETF for investment then?

Investment goals and allocation

The most critical question you have to ask yourself is what is your investment goals, risk appetite and portfolio. When I first started my investment journey, I thought that since I am young with high earning power, I can afford to sit out the roller coaster rides of the stock market and went 100% into equity without allocating any part to lower risk financial instruments like bonds or fixed deposits.

While being young does give you the ability to ride out the storms of the stock market, investment is also an emotional game and having some emotional security during the doom and gloom of the stock market (eg. Global Financial Crisis and Covid) is actually mentally reassuring.

Furthermore, allocating some parts of your portfolio into low risk liquid investments like t-bills also provide you with the liquidity to buy more during these unexpected market crashes. I was unable to purchase more during the market crashes as all my liquidity were tied up in the equity market. With hindsight, I would have done a 80% equity market 20% bond market split for my portfolio.

Home country bias

Another popular issue which arises in home country bias, readers in Hong Kong or Singapore or Australia like to ask whether they should buy the ETFs of their local stock market as those are companies they are familiar with and easily accessible from their existing bank accounts. 

In general, having exposure to your home country’s stock market if you have market insights and knowledge is not a bad idea. I would still recommend building the basis of your portfolio with the US market or with the global world market. The key reason is the liquidity and volume of trades available within the US market dwarfs that of any other market. Most of the large engines of growth in the upcoming years is also very US centric. As such, I believe you should build the ETF base of your portfolio on the US or global market.

Do you have any ETFs to recommend?

This is always a very dangerous question as it shades into financial advice, so the regular disclaimers apply that this is not financial advice and please do your own due diligence and read up on the portfolio materials. What I can share is what I am investing in myself which include the following ETFs: 

  • VTI: Vanguard Total Stock Market ETF covering the entire US Stock Market
  • VOO: Vanguard’s S&P 500 ETF tracking US’s largest companies
  • VNGA80: ETF tracking 80% portfolio in global stocks and 20% in global bonds

Hopefully this gives some insight into how to start building your own portfolio, and if you want to have more tailored advise, feel free to reach out on my socials!