About a week ago I explained why exchange-traded funds are, in my opinion, great for people starting out in the stock market. Being a brand new investor myself and because I want to put my money where my mouth is – although not really, because money tastes foul – I’ll explain my personal exchange-traded fund strategy and the current set-up of my portfolio. Hopefully this way people looking to become ETF aficionados pick up some useful tips and tricks to build their own portfolio.
Before continuing, however, I once again want to stress that I’m not a professional investor, not by a long shot. Everything I am doing to create my ETF portfolio is based on months of research and tailored to my personal situation. So please don’t copy my strategy thinking it will be fine because this one random Belgian who doesn’t like waffles is doing it.
Rules of the game
Before I set out to look for the perfect ETF, I decided to check out what I like to call the rules of the game. Because the financial industry is highly regulated, we will have to take into consideration many rules that could interfere with our ideal plan of action. As a result, I dove headfirst into this beautiful thing called Belgian national legislation. And regional legislation. And European legislation. Basically, lots of legislation.
When I surfaced again, the result was quite surprising: the perfect ETF for a Belgian citizen from a regulatory and tax perspective is located in Ireland, not registered in Belgium, doesn’t pay any dividends and the weight of bonds in the ETF is less than 25%. Here’s why:
- Located in Ireland: beneficial treatment of dividends received by the fund.
- No registration in Belgium: stock market tax down from 1% to 0.25% for accruing funds.
- No dividends for shareholders: dividends are best left in the fund, otherwise a 15% foreign withholding tax and another 25% Belgian tax on dividends will be applied.
- Total amount of bonds remains below 25% of the fund’s portfolio: no capital gains taxes will be applied to your ETF shares if fixed income assets in the fund are kept to a minimum.
Again, this applies to me personally. I know, for example, that the situation for Dutch investors is completely different since they are better off with Irish dividend paying funds. And to all of you American readers hardly any of this will apply.
So before you start throwing your money at ETF shares, be sure to read up on what’s best for you. When you know the rules of the game, you’ll immediately find that nine in ten ETFs available aren’t a wise investment, which is a really big advantage and makes picking the perfect exchange-traded funds later on a lot easier.
My strategy for choosing the right ETFs
Still, 10% of all exchange-traded funds out there is still a prety big ETF list. To narrow that list down it is important to come up with a sound strategy that you stick to in the long run. I decided to follow the Bogleheads’ philosophy of investing, which basically states that you develop a workable and easy to understand plan that is not too risky and offers enough diversification. As I’ve explained last week, ETFs provide all of these requirements and more.
Because I’m only 25 years-old and because bonds are a no-go tax-wise, I decided not to include any bond funds. As I grow older, though, it might be wise to increase the percentage of bonds in my portfolio since they are less volatile than stocks. I also didn’t include any commodities because I don’t know anything about them and don’t understand them at all. Consequently, I was left with stocks only. Another 5% of ETFs gone!
What I also wanted from my ETFs was a low expense ratio (preferably below 0.3%), a rather high daily trade volume and cheap transaction costs. The iShares ETFs by Blackrock are one of the few ones that actually meet these criteria since their expense ratios are by far the lowest, they are traded fairly often and list on the Euronext stock exchange in Amsterdam, which is easily accesible to me. Another 4% of ETFs gone! 99% of ETFs down, only 1% more to go!
Now it came down to actually picking ETFs based on their underlying indices and fundamentals. Ultimately, the strategy I felt – and still feel – most comfortable with is owning worldwide stocks based on their market cap. Why? Some might call it gut feeling, but to me instant worldwide diversification was a definite decisive factor. I sleep easy at night knowing that my money is invested in the largest companies worldwide.
My favourite ETFs
Finally, I picked my three favourite ETFs. Three!? The reasons for choosing three exchange-traded funds instead of a more simple two- or even one-fund portfolio are actually quite logical.
First, iShares doesn’t offer an ETF that truly captures the entire world. Their MSCI All Country World Index comes close, but is limited in its exposure to emerging economies. The expense ratio of the accruing version of that fund is also quite high and the trade volume is rather low.
Second, I wanted to increase my exposure to European countries. Most worldwide indices are heavy on US corporations (over 50%) and even though that’s not a bad thing per se, I feel more comfortable with a small home
country continent bias because I understand Europe’s markets and policy-making better.
As a result, the three ETFs I finally decided on are:
- iShares Core MSCI World UCITS ETF (Acc): this exchange-traded fund invests in developed economies, has a solid track record, high trading volumes and an expense ratio of only 0.2%. The bid-ask spread is quite low too, which makes buying additional shares easier.
- iShares MSCI Europe UCITS ETF (Acc): to counterbalance the US-heavy World ETF I decided to add a broad European fund. This one also follows its underlying index closely, even though the expense ratio is 0.33%.
- iShares MSCI Emerging Markets UCITS ETF (Acc): to round out my international exposure, I also added iShares’ emerging markets ETF into the mix even though it’s slacking a bit in following its index and the expense ratio of 0.68% is quite high. I will evaluate my position in this fund one year from now to see if it is worth keeping around.
How I buy my shares
When you have three funds like I have, you’ll have te decide on how much of your money you want to pour into each ETF. I’m going for a 70% All World, 20% Europe and 10% Emerging Markets mix because that will provide me with an exposure of 40% to US stocks, 45% to European companies, 10% to emerging market securities and 5% to the rest of the world. If you want to determine an allocation based on worldwide diversification on your own you’ll have to dive into the principles and stocks of the underlying indices.
Finally we get to do some buying! Just grab all your cash, run to your broker and tell him to dump everything into the ETFs of your choice! Or you could apply a dollar cost averaging strategy like I do to reduce the impact of volatility on that single large purchase. Dollar cost averaging basically means that I spread my buying frenzy over a certain period of time to average out market volatility during that period. As a result, I won’t run into the problem of buying at the top of the market just to see it drop down to all-time lows the next day.
That’s why I have been investing about 8% of my available cash into the three ETFs for over three months already. This way I’ll minimize downside risk over the period of one year (8% times 12 months makes almost 100% of my cash holdings).
I understand that all of the above is a lot to take in. After all, it’s over two months’ worth of research into tax treaties, legislation and investing strategies crammed into a single blog post of only 1500 words. Nevertheless, I hope to have shown you how I came to my own strategy and built my own portfolio, and I hope to have mentioned some important things to take into consideration when deciding on an ETF strategy.
If you feel like you need to take on an insurmountable task to start investing in exchange-traded funds, don’t. Half a year ago I didn’t know anything about ETFs. I am, moreover, still not sure my strategy is 100% waterproof, but I am convinced that I at least made the right choice nine out of ten times. I am confidently putting my money in the market, which ultimately was one of the bigger barriers to my financial independence. We’ll see in a couple of months how my strategy turned out and I’ll definitely provide feedback on this learning experience.
Of course, there is always more to learn, so that is why I would like to know your thoughts on ETFs. Are you invested in them? And if so, which strategy do you stick to?