How Do I Evaluate an ETF?

Buying stocks is not like on Amazon.com. They aren’t listed by “Amazon Choice” or “Top Sellers.” This is probably a good thing, but I do wish I could sort by meme stocks (GameStop and AMC). Those are sure things.

Start with Google. Search “S&P 500 ETFs,” “Small Company ETFs,” or “Yankee Candle ETFs” and there will be an article comparing and listing several options. Okay, maybe not for the Yankee Candles but for sure the first two. Once you find some options, you can use the tools listed at the bottom to compare. Here are some example ETFs with similar goals: VOO and SPY - S&P 500 ETFs, QQQM - NASDAQ ETF, SCHG and VUG - Large Cap Growth, SCHA and VA - Small Cap ETFs. For the rest of the letter, I’ll compare VOO and SPY.

Step 1: Know What You’re Buying

Evaluate an ETF or Fund based on the basket of securities it holds or tracks. Ultimately, nothing else I will talk about matters if the product holds worthless stocks. For example, let’s say in 1980 you bought the “Floppy Disk ETF,” and it holds all companies involved in making and selling Floppy Disks. It doesn’t matter how low the expense ratio is or how well it did the past ten years because by the time the “DVD ETF” comes out, your Floppy ETF is probably worthless. There are some fantastic ETFs that track the big indices (like the S&P 500) and others that track a more niche industry (like water, clean energy, or the airline industry).

Every ETF tells you exactly which companies it holds and the size of the position. Under the portfolio or holdings tab, ETFs list the top ten holdings (you can easily download the entire list) and the total number of holdings. The more holdings in an ETF, the lower the potential reward and risk. The fewer the holdings, the higher the potential reward and risk. Also, if you purchase an ETF that is isolated in one industry, you increase your risk. Going back to your Floppy Disk ETF, it takes one invention to destroy your performance. New inventions are not the only threat to niche industries. The “free market” is not actually very free in the USA (or anywhere) and government regulation and taxes can drastically affect performance.

Holdings:

• VOO - 506

• SPY - 503

TOP 5 Holdings:

VOO

1. Apple - 7.67%

2. Microsoft - 6.77%

3. Google - 3.55%

4. Amazon - 3.11%

5. NVIDIA - 2.8%

SPY

1. Apple - 7.36%

2. Microsoft - 6.45%

3. Google - 4%

4. Amazon - 3.26%

5. NVIDIA - 3.23%

Step 2: Look at the Cost

This is not the cost per share but the expense ratio. ETFs are investment products offered by companies. This means they come with a slight price tag called an expense ratio. Unlike individual stocks, which are tiny shares offered by companies, ETFs are groups of stocks, bonds, or other funds. The expense ratio is what allows the company to list and maintain the ETF. Hypothetically, let’s say the price of all the stocks in an ETF stays the exact same for an entire year, the value of your investment in the ETF would decrease by the expense ratio. VOO has a .03% expense ratio which means they charge 30 cents for every $1,000 you own. I think that’s a very good deal. If you don’t agree, you can try to buy and sell stocks to stay in the ratio of the S&P 500… be my guest. Or, you can have an account with Fidelity and purchase one of their ZERO expense ratio index funds (not an ETF).

Large index ETFs typically have lower expense ratios than niche ETFs. It is important to compare expense ratios of similar funds. QQQM’s expense ratio is 0.15% which is much higher than VOO and SPY, but if you find another NASDAQ ETF with a lower expense ratio, let me know.

*You’ve probably seen the ads for QQQ. QQQM is the same thing as QQQ but Invesco created it in 2020 as a lower cost option for long term, individual investors. QQQ’s expense ratio is 0.2% compared to QQQM’s 0.15%.

Expense Ratio:

• VOO - 0.03%

• SPY - 0.0945%

Step 3: Look at the Returns

Past performance does not guarantee future results, but looking at the past performance of an ETF can help you compare and make informed decisions. When you get to an ETFs info page, there are a bunch of numbers and graphs. Ignore them all and go straight to performance and look for Annualized Returns. For long term investors, look at the 10 year and “since inception” performance numbers. The Year to Date (YTD), monthly, 1 year, or 5 year performance numbers are cool to look at but ultimately too short of a time frame. If you are investing in the stock market in the hopes of big gains in the next year or two, you are probably going to be upset. Any money you put into an ETF should be there for 10+ years.

When comparing ETFs, ensure you’re comparing apples to apples. If you’re comparing “since inception” performance numbers, look at when the ETFs/funds you’re evaluating were created. An ETF created in 2009 (at the beginning of a long bull run) is going to look better on paper than an ETF created in 1990. The higher percentage option is not always the better option.

There is also the yield percentage, usually the “SEC 30 Day Yield” or “TTM Yield.” The yield is the distribution paid out per share. When you buy the ETF and click “reinvest dividends,” the yield will be used to purchase additional shares automatically. Dividends and the benefit of reinvested dividends are calculated into the annualized return numbers. So, you don’t really need to compare yields.

There is a cult of “dividend hunters” who hunt for stocks and ETFs that generate the biggest dividends. The opposite of dividend stocks is growth stocks. Dividend hunting alone is overrated, but that is a rant for another day.

10 Year Return (Inception date varies by 17 years, so 10 Year Comparison is more fair):

• VOO - 12.77%

• SPY - 12.52%

Winner: VOO. The lower expense ratio and increased 10 year return are the reason I own VOO instead of SPY.

Luckily, you don’t have to spend hours on Google flipping back and forth between tabs to compare ETF and mutual funds. Here are a couple of tools that compile data from ETFs and mutual funds to allow you to compare multiple funds at once:

Mutual funds: https://fundresearch.fidelity.com/fund-screener/

ETFs: https://etfdb.com/tool/etf-comparison/

That is kind of it! Once you know what you’re buying, compare the costs with other similar ETFs, and check for long term performance, you can sit back and wait! And wait… and wait. Building wealth takes patience.

Call to Action

Check the holdings, expense ratio, and performance of the ETFs you hold. If there is a better option, think about adjusting your investment plan. Since Mike and I have been writing this, I have found several better ETFs than I had bought previously (thanks to Mike).

What We’re Reading/Listening To:

Podcast: Freakonomics - #555 New Technologies Always Scare Us. Is A.I. Any Different? It’s impossible to stop the wheels of inventions. Is now any different from previous technology scares?

Debrief on Deck

Next week, Mike will go into detail about a 'Balanced Portfolio.’ Balancing between Game Stop, AMC, and Yankee Candle apparently isn’t the best or ‘safest’ retirement plan. Gotta risk it for the biscuit, right?

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (X (formerly Twitter) and Instagram).

Until then, stay the course.

Disclaimer