Since the launch of the first ETF in 1993, the exchange traded fund industry has gained popularity growing its assets by leaps and bounds. There are currently over 1,560 exchange traded products listed in the U.S., with almost $1.7 trillion in assets under management.
Like mutual funds, ETFs also pool investors’ assets to buy stocks or bonds according to their stated strategy. However, ETFs are considered to be a less expensive and more tax efficient means of gaining exposure to an assorted array of asset classes, including domestic and international stocks, bonds and commodities, as compared to mutual funds. More importantly ETFs trade just like stocks, allowing investors to actively participate in trading on a regular basis.
While there are a number of factors including the index tracked by the fund, issuer and assets under management, and diversification which investors should look for before investing in ETFs, cost is an important factor that cannot be ignored (read: 3 Biggest Mistakes of ETF Investing).
In the long run, cheaper funds can drastically outperform the expensive ones, at least when other factors remain constant. Though investors should consider other costs involved in investing such as, trading commissions, bid/ask spreads and discounts and premiums to NAV, expense ratio is the major cost.
Consider an expense ratio of 1%, a fund of $10,000 invested at 8% annual return will grow to $19,672 in 10 years, while the same fund invested at an expense ratio of 0.1% will grow by a higher amount of $21,390.
Moreover, the difference between the total return becomes quite significant as we increase the holding period. Considering the same parameters, with an expense ratio of 0.1% the fund of $10,000 will grow to $97,869 in 30 years (at the same 8% rate of return). The same fund will however grow to a much lesser value of $76,123 with an expense ratio of 1% (read: 3 ETFs You Can Love Forever).
Keeping costs in mind, we have highlighted below three ETFs with ultra-low expense ratios that should be considered by investors for their long-term portfolios. More importantly, as an added advantage, these dirt cheap products also have a Zacks ETF Rank of #1 (Strong Buy), further underscoring their potential to outperform this year.
Schwab U.S. Large-Cap Growth ETF ((SCHG - ETF report))
This fund provides broad exposure to large-cap U.S. stocks exhibiting growth characteristics. These growth companies are also expected to perform better over the long haul. These firms look to use their surplus cash for stepped-up capital investments and hiring.
Thus in order to provide exposure to large cap growth stocks, this passively managed fund tracks the Dow Jones U.S. Large-Cap Growth Total Stock Market Index, holding a basket of just under 400 stocks.
The fund is slightly more titled towards the Information Technology sector which forms 28% of total fund assets, followed by Healthcare (17.2%) and Consumer Discretionary (15.3%) (see all Top Ranked ETFs here).
Consequently, Apple, Google and Microsoft are the top three holdings of the fund, together forming around 12% of assets.
The product has returned 23.61% in the last one year and is up 0.77% in the year-to-date time frame. Moreover, the fund has provided an outstanding 50% return during the last three years. The fund has a dividend yield of 1.05%.
The fund from money manager Schwab is the cheapest in its category, charging a meager 7 basis points as annual fees, managing assets worth $1.2 billion. Moreover, the fund is pretty liquid with average volume of 177,662 shares traded a day, which results in a tight bid-ask spread, reducing the fund’s total costs.
Schwab U.S. Small-Cap ETF ((SCHA - ETF report))
Launched in November 2009, SCHA seeks to provide exposure to small cap U.S. companies and tracks the Dow Jones U.S. Small-Cap Total Stock Market Index.
The fund holds a large basket of 1753 stocks and is very-well diversified among its individual holdings. None of the individual stocks form more than 0.3% of total fund assets. However, as far as sector allocation is concerned, Financials and Industrials together form almost 40% of total fund assets, suggesting some sector specific risks.
SCHA is a nice blend between growth and value stocks, having 30% exposure to growth stocks, 28% to value stocks, while the rest is invested in stocks having both these characteristics (read: Best ETF Strategies for 2014).
The fund has performed quite well over the last three years delivering a return of 51%. Moreover, it has returned 24% in the last one year.
SCHA charges 10 basis points as fees and has relatively tight bid/ask spread suggesting none or slightly extra cost. The fund has amassed $2.1 billion since its inception.
Financial Select Sector SPDR Fund (XLF - ETF report)
For investors seeking more concentrated exposure to the Financials sector, XLF is a good way to do so. The sector is expected to perform well as long-term rates are likely to creep up.
The fund is the largest and most popular ETF in the Financials space with an asset base of $18 billion. The fund holds a total of 84 stocks giving investors exposure to some well-known financial firms including Wells Fargo & Company, Berkshire Hathaway and JP Morgan Chase.
The product has added handsome returns over long periods beating popular market indices. It has returned a stellar 184% in the last 5 years versus 136% for the S&P 500 index. The fund has returned around 23% in the last one year and has an annual dividend yield of 1.45%.
Moreover, with an expenses ratio of 18 basis points, it is one of the cheapest options in its space.
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