Client Portals

Check ETF ingredients before choosing flavors3 min read

Feb 22, 2011 - John Osbon ( 4 mins to read)

With nearly a thousand flavors now available at the ETF buffet, where do you even begin to fill your plate?

Start with the major food groups. A sound investing plan begins with intentional, reasoned allocations to distinct asset classes. While it is easy to become enamored with specific stocks or ETFs, determining how to spread investments across asset classes, based on expected risk and return, is the first step. These allocations will have a dominant role in determining overall performance of a portfolio.

Read the ingredient labels. After determining appropriate asset allocations, it’s time to truly understand what each ETF holds as funds vary widely and their names rarely tell the full story.

The vast majority of ETFs are index investments, meaning they are designed to track the performance of published indexes or benchmarks. But within any broad asset class one will find many indexes, each tracked by different ETFs with their own unique features. More on indexing

Examples of large cap US stock indexes

Index Asset class Stocks

In index

Representative ETF symbols
Dow Jones Industrial Average Large cap US stocks 30 DIA
S&P 500 Large cap US stocks 500 SPY, IVV, VOO
MSCI US Broad Market Index NYSE and Nasdaq stocks 1200-1300 VTI
S&P High Yield Dividend Aristocrats Index Large cap stocks that have increased dividends every year for at least 25 years. 50 SDY

Different indexes, different approaches

Being in the same asset class does not mean that indexes will behave the same way. Here’s why:

  • Some indexes have strict mathematical rules about when companies enter or exit. Others are highly subjective. For instance, the editors of the Wall Street Journal determine what stocks are included in the Dow Jones Industrial Average.
  • Many flavors have sub-flavors. For instance, within large cap stocks, one finds not only broad indexes, but also those specific to style, industry or geography. Some use very exacting standards in choosing stocks. The S&P High Yield Dividend Aristocrats Index, for example, is one of several indexes that include only companies that have consistently raised dividends year after year. Other high yield ETFs.
  • Rules for weighting stocks in an index may differ. The S&P 500, Nasdaq Composite and most other indexes weight stocks by market capitalization, while the Dow is price-weighted.

Different rules, different results

How ETFs are managed can make a big difference in performance. Vanguard’s VWO and iShare’s EEM are both designed to track the performance of the MSCI Emerging Markets Index. But their approaches vary considerably. VWO does it with about 900 stocks and EEM with less than 800. (The index itself includes about 800 companies.) The top holdings of the funds are not identical. Further, VWO’s published expense ratio is 27 basis points; EEM’s is 69 basis points. Because of these differences, over the last two years, VWO has outperformed its rival.

The different characteristics of indexes and ETFs described in this post are not meant to indicate which ETFs are “best,” only that the effect of seemingly subtle differences can be considerable. It is a dramatic case of caveat emptor – there’s no way to know what you’re buying without doing the research yourself or working with an advisor who has. It pays to be picky about ingredients.

For a pdf listing of all ETFs – more than 970 – compiled by State Street, click here.

delivered to your inbox


This communication may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.”

“Historical performance is not indicative of future results. The investment return will fluctuate with market conditions.

Past performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor.

Investment strategies, philosophies, allocations and holdings are subject to change without prior notice.

This communication is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice.

While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.

Adviser does not endorse the statements, services or performance of any third-party vendor.

Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable.

Any IPO alerts are purely informational and should not be construed as recommendations to invest.

Adviser is not licensed to provide and does not provide legal, tax or accounting advice to clients. Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.

Any case studies or hypothetical client profiles are for demonstration purposes only. They illustrate the breadth and depth of the many clients we represent at various life stages. Any similarities to actual Adviser’s clients past or present are strictly coincidental. Individual advice and results will vary based on each client’s circumstances, objectives and prevailing economic conditions.