The omicron variant of the Coronavirus has left many investors of small-cap stocks speechless. They had previously boasted about how their stocks were constantly outperforming the market. It seems the risk was still present, though. The omicron variant has made investors more wary and wondering whether single stocks are the right asset to invest in. Are ETF’s a better option?
Why small-cap stocks suffered from omicron
During the fall of 2021, small cap stocks were outperforming the market by a long shot. During an uncertain time of inflation, people looked at them as a form of reassurance. They had been reaching all-time highs. Concerns for the coronavirus had been increasing though, as the “Corona-season” neared. And, indeed, a new variant of the coronavirus, the Omicron variant proved devastating for small cap stocks. Now, investors’ outlook for the future is somewhat mixed: Cheaper stocks make the market more attractive, but the inflation measures of the Federal Reserve have many investors concerned. While omicron is still raging on, some wonder whether it is wise to buy more small-cap stocks, seeing as there is a new variant tearing them right back down every winter. Now, investors are looking toward new earnings reports, to see whether companies can still thrive during the effects of inflation measures and its fears. This constant tug of war between inflation and Covid-19 makes investors uncertain. They still want to make profits, because not doing so is also considered losing, since inflation will eat away at your money supply. Is there a better way?
Turns, out there might be! When investors look to the future and pick a industry they would like to invest in, instead of trying to pick out a single company that may or may not grow exponentially, they could buy an ETF. Mind you, this article doesn’t suggest making ETF’s the only component of a portfolio, merely a significant one, seeing as investors are very uncertain and (rightfully) weary of small-cap stocks. SO, what is an ETF and why could it be beneficial for a portfolio?
ETFs – the basics
ETF stands for Exchange traded fund. This means that it is an investment which is traded on a stock exchange. An investment fund is a company that invests in other companies. It can be actively or passively managed. Other forms of investment funds are hedge and Mutual funds. Hedge funds are more exclusive than ETFs or MFs as fees are higher and there is a minimum deposit requirement. Mutual funds are very similar to Exchange traded Funds. The only difference is that Mutual funds are not sold like stocks on a stock exchange. Instead, Mutual Funds can only be traded at the end of the day with the Fund’s Net asset Value Per Share. Exchange traded Funds can be traded throughout the entire trading day like stocks. In both though, you don’t get any voting rights. Even though you are buying a share of a company, your investment only represents ownership in the shares that the firm has bought, not the actual firm, which you have to pay fees for (the depend on the type of fund). Mutual Funds are older and a bit more complex, which is why I am going to focus on Exchange traded Funds from here on in.
The management of ETFs can be mainly classified into active and passive. Passive ETFs tend to replicate stock indexes or try to replicate the return of an industry in general by investing in many shares of that industry. Active management refers to Funds which focus more on “investing for the investor”. When you’re investing in an active Fund, you’re basically paying someone to investor your money for you. And don’t forget, that money isn’t the money that you paid for the share: there are additional fees solely to pay managers. The general rule is: the more complicated the job is for managers, the higher the fees are.
ETFs don’t just invest in stocks. They can invest in bonds (I have to note that in times of extreme inflation bonds are not the best investment choice, unless they deliberately hedge against inflation) and even cryptocurrencies. When you research an Exchange Traded Fund, look for how they invest. Do they invest long-term or short-term? In stocks or other assets as well? Especially with the pandemic it’s important to keep in mind that a new variant might be right around the corner, so be weary.
Index Funds – for passive investors
Are you looking to beat the market? Or do you want to replicate it, seeing as it is a relatively secure way to hedge against inflation? Then index funds might be worth looking into. These are a passively managed type of ETF. When I say passive, I really meant that it’s almost not managed at all. These types of funds replicate stock indexes, like the Dow Jones. The Dow Jones has 30 firms. The Fund DIA replicates this by buying all 30 stocks of the Index. Similar funds include the VOO, SPY and SWPPX, which all track the S&P 500 index, an index which tracks 500 large firms. There are many more ETFs for passive investors that don’t know much about investing. Even as an aggressive or enterprising investor (as Benjamin Graham put it), you wouldn’t be judged by putting some small amount into one of these funds. Stock-market legend Warren Buffet is a notorious advocate for some of the funds mentioned above.
“I recommend the S&P 500 index fund and have for a long, long time to people.” - Warren Buffet
What to watch out for in Funds
If you’ve decided to go into funds, no matter what type of investor you are, there are some things you should look out for:
Fees: If you’re going into funds, you need to be weary of fees. Even when you know them you need to find out how much they could actually eat away from your gains. Remember the rule: the more complicated the job is for managers, the higher the fees are. Also, take a look at what your broker charges you specifically for ETFs. That might also be an important figure.
Looking towards the past instead of the future: If you’ve heard of a hot new ETF that exploded for whatever reason, be cautious. The prices of stocks in the ETF probably rose exponentially, meaning many new investors are willing to invest in it. But what is the manager going to do? Investing in those stocks again would be foolish, as those stocks rose in value and are probably overvalued. New stocks need to be researched and if the industry as a whole went up, those could be insignificant and overvalued as well. Not doing anything with the money would reduce overall gains and inflation would eat away at it, especially now. I think you got the message. When looking towards an ETF, don’t just look at past performance. More things impact it. Research its investment style and assess whether it could do well in the future. You’re only buying an ETF to diversify instead of pouring a lot of money into single stocks. Still, research the industry that the ETF is investing in and the asset types (remember to tread carefully with bonds) it buys.
Management changes: When you do look toward the past and find you do want to invest (provided you think that the manager will continue to excel), there is still one issue. What if the management changes? Changing management may not sound disastrous, because after all, it’s the same company with the same investing style, right? Well, no. Different managers have different approaches. And if the one that you’ve put your confidence in leaves all of the sudden, disaster could ensue. If you find a fund you like because of past investment style and find out there’s a different manager all of the sudden, it might be best to look elsewhere.
Conclusion
The pandemic has brought on increased volatility and mixed feelings for the future. Instead of blindly trying to pick out a stock from a sector you like, why not give the ETF a try? They make it easier to invest in assets that are hard to invest in, diversify with a single investment and can fit your investment style. Be wary of the issues above and note that diversification is not always a good thing. In the pandemic though, it might seem like a good idea, maybe even for extreme enterprising investors.
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