ETFs or exchange traded funds are relatively new investment tools but they’ve caught on fast. Dubbed by some as “mutual funds for the 21st century,” ETFs give you the ability to make diversified sector bets or track an index while still maintaining the regular control and trading of stocks. This ability to control volatility with even a small nest egg but still be in the driver’s seat has made the ETF a staple for many retirement portfolios.
But the top ETF for your particular strategy is hard to identify now that these exchange traded funds have gained popularity. There are so many flavors it can be downrighty confusing. There are bond ETFs, sector ETFs and even an ETF for specific regions of the world.
I’m here to take the guesswork out of your ETF investing today with nine clear picks for your portfolio. These ETFs span a wide variety of strategies, so I’m sure you’ll find an exchange traded fund that works for you.
Best Sector ETFs
The best sector ETFs right now are health care funds. My absolute favorite ETF is the iShares DJ US Medical Devices Index Fund (IHI). This sector ETF has been performing especially now that the health care debate has drawn to a close and the prospect of broader insurance coverage means bigger sales for medical device companies.
Top components in this exchange-traded fund include large-cap companies Medtronic (MDT), Thermo Fisher Scientific (TMO) and Stryker (SYK), however this ETF also allows investors to have a foothold in a large number of smaller biotech firms without taking on the big risk of a small-cap medical stock. If you’re a little more aggressive, one of the purer sector-based ETF plays is the iShares Nasdaq Biotechnology Index Fund (IBB).
My second favorite sector for ETFs right now is aerospace and defense. Particularly, I like the iShares DJAerospace & Defense Index Fund (ITA). It’s top three component stocks are United Technologies (UTX), Boeing (BA) and General Dynamics (GD). You may think that with the Iraq “surge” now waning and with President Obama accepting a Nobel Peace Price in December that defense is on the decline. That is not the case. Barack Obama has planned to deploy up to 42,000 soldiers to Afghanistan and defense budgets are not facing the same cuts as other departments. A different flavor of ITA is the Powershares Aerospace & Defense Portfolio Fund (PPA), which has many similar holdings but a different weighting for the companies – including Honeywell (HON) as its top component. Both of these defense ETFs are strong since they track the same companies, but I lean more towards the iShares ITA fund due to its makeup.
Low-Risk Bond ETFs
Many investors get into ETFs for diversification, because these exchange traded funds allow you to spread your money around a certain index or sector. For even more diversification and to reduce volatility in your portfolio, you can add bonds. In a taxable account, a good choice would be the iShares S&P National AMT-Free Municipal Bond Fund (MUB). This is a broad, tax-free bond fund. It costs 0.25% annually. With money markets offering near-zero rates, it’s just silly to park any of your nest egg in cash. Bond funds are a better bet for now, and since you can trade these ETFs just like stocks it’s a cinch to rotate out of these holdings once interest rates increase down the road. Short-maturity corporate and municipal bond ETFs like the Vanguard Short-Term Bond Fund (BSV) could also be a good investment, or the SPDR Barclays Aggregate Bond ETF (LAG) which is the smallest in the category but also the most affordable.
As a rule, bond funds will not double your money overnight. However, they are good low-risk alternatives to cash right now. I almost always recommend investors get fully invested since it’s better to put your money to work than to let it simply track the rate of inflation. If you’re still sitting on cash, this is a great alternative that will provide better returns and very minimal risk.
Keep reading for the best global ETFs and the best currency ETFs
You may think that I’m going to pitch emerging market ETFs here … but the thing is, many China ETFs have already seen the lion’s share of their gains and don’t have much room to run in my mind. That means looking to other regions that are just hitting their stride.
A real diamond in the rough right now is the Global X FTSE Nordic 30 ETF (GXF). You may not think of the frozen north of Europe as a hot region to invest in, but the Nordic 30 include some big names like Novo Nordisk (NVO), Statoil (STO), Nokia (NOK) and Ericsson (ERIC). Indeed, there are alarming signs of weakness in the euro zone thanks to sovereign debt fears in Spain, Portugal and Greece. But the Nordic nations are living within their budgets and companies there are actually doing quite well. In fact, the euro zone country deemed to be a lowest risk was Finland, which is on relatively solid ground, along with Nordic neighbors Sweden, Denmark, and Norway that are represented in the GXF fund.
If you’re looking to play the recovery, you want to buy at the bottom and ride the growth of the region. Sure, you can buy momentum in a China ETF – but buying near the top doesn’t give you much room to room. It may be a bit risky, but the GXF is a good global play right now and is much better than other Europe ETFs.
If you simply have to buy into Asia ETFs, look across the Sea of Japan and consider the SPDR Russell/Nomura Small Cap Japan ETF (JSC). Like Europe, Japan is not exactly in favor with investors right now. It was perhaps the only global economy to miss out on the bull market of 2010 as stimulus plans failed to pack any punch and deflation continues to cripple the economy.
But amid the doom and gloom are reasons for hope in Japan. Factory output recently logged its ninth consecutive month of growth, with November results up 2.6% from October results. The dollar’s recent recovery has come at the expense of the yen, and a cheaper currency promises to give a boost to the country’s export market — a critical part of the economy and an important element in breaking the influence of stagflation and falling prices.
Most Japanese ETFs like are tilted towards mega-cap Japanese stocks on U.S. exchanges like Toyota (TM), Honda (HMC) and Sony (SNE) as well as the biggest players on Tokyo’s Nikkei index. This provides a level of blue chip stability, but also means you have to settle for conservative growth. I like the Russell/Nomura Small Cap fund because it provides access to up-and-comers instead. Top components are small companies that are on the way up – and could surge overnight on buyout news or just small improvements to economic indicators. The proximity of Japan to China could mean big things for many small Japanese stocks, and the JSC fund is a great way to share in those returns.
If you’re still hung up on China and emerging markets, I can understand. There are a lot of great stocks there. But remember that ETFs are a basket of stocks like a mutual fund, so you’re getting the good with the average and the bad. If you want to play China, I recommend buying the best stocks and not going with an ETF. Same for South America. There are great companies in Brazil, Chile and elsewhere that are going strong. Don’t accept a grab bag when you can make a focused play on what’s working in these regions.
But if you simply have to go emerging markets, try the WisdomTree Dreyfus Emerging Currency Fund (CEW). Low interest rates have been one of the keys to the recovery efforts in the U.S., and all indications are that record-low rates are here to stay. We could see a modest boost to rates in 2010, of between 0.25% and 0.5%, but that should be it for the better part of a year – and perhaps even until late 2011. The dollar is due for a fall with an outlook like that.
Several developing economies are currently paying money market rates in excess of 7% — staggeringly-high rates for investors accustomed to returns on fixed income investments below 1%.To get a piece of this pie, CEW may be a good play. The ETF invests in a basket of money market funds in emerging markets, ranging from South America to Eastern Europe to Asia. Protection against a further drop in the U.S. dollar is an added benefit of CEW, although this obviously comes along with the risks posed by a strengthening greenback. But since Washington’s debt continues to skyrocket, interest rates remain low and the economy is still pretty sluggish, I am banking on a weak dollar in 2010 with my strategy. You should too!
How to Buy ETFs
Some final thoughts: When you’re buying ETFs that these funds frequently have low volume and therefore higher volatility. Though I try to stick on ETFs are based on an index like the S&P to reduce risk, it is still difficult to pin down prices on some days. That’s why I always recommend buying these ETFs during market hours since some funds aren’t priced properly after the bell. And use limit orders to protect yourself, since a market order could result in you overpaying for shares.
And don’t forget that your ETFs are a great way to identify individual stocks, too. Keep track of the component stocks for any fund that you purchase – and don’t be afraid to rotate out of the ETF and into an individual company if you notice it is outperforming the broader fund. Zeroing in on the best sectors or the best regions of the world is great, but zeroing in on the very best individual stocks is the key to making truly impressive profits.
Louis Navellier owned shares of AAPL in personal or client portfolios as of this writing.