Many investors know that there are thousands of stocks listed in the US markets.
What is less well known is that there are also thousands of ETFs, or exchange-traded funds.
Picking the right ETF can be just as daunting and confusing as picking the right stock.
Here are five of the most popular US-listed ETFs that every beginner should take a look at.
1. SPDR Dow Jones Industrial Average ETF (NYSEARCA: DIA)
Among the major US indices, the Dow Jones Industrial Average Index (DJIA) has the longest history of more than a hundred years.
The index consists of 30 blue chip companies that include many famous names such as Apple (NASDAQ: AAPL), Coca-Cola (NYSE: KO), McDonald’s (NYSE: MCD), Nike (NYSE: NKE) and Visa (NYSE: V).
Rather unusually, DJIA is price-weighted, meaning that stocks with a higher absolute share price take up a greater proportion of the index.
Hence, McDonald’s, with a share price of US$268.89, has almost double the weight of Apple, which has NASDAQ’s biggest market capitalization company but a share price of US$134.76.
2. SPDR S&P 500 ETF (NYSEARCA: SPY)
The S&P 500 Index is the most followed stock index in the world with hundreds of billions of US Dollars tracking it.
It is a market capitalisation-weighted index (same for the three ETFs below) consisting of US’s 500 biggest companies.
The top five companies – Amazon (NASDAQ: AMZN), Apple, Alphabet (NASDAQ: GOOGL), Microsoft (NASDAQ: MSFT) and Tesla (NASDAQ: TSLA) make up about a fifth of the weightage in the index.
3. iShares Russell 2000 ETF (NYSEARCA: IWM)
The Russell 2000 Index has 2,000 companies that are ranked 1,001 to 3,000 in terms of market capitalisation.
It is an index that reflects the performance of small US companies.
Most of these companies, unlike those in DJIA and S&P 500, have little or no earnings overseas.
Thus, these companies are more sensitive to the US economy than the world economy, and the movement of the US Dollar has little impact on their earnings.
4. Invesco NASDAQ 100 ETF (NASDAQ: QQQ)
The NASDAQ stock exchange is home to many technology companies.
The Invesco NASDAQ 100 ETF follows the NASDAQ 100 Index, not the NASDAQ Composite Index.
Therefore, this ETF holds the 100 largest companies instead of all the companies listed on the NASDAQ stock exchange.
While the performance of these two indices is not exactly the same, the difference is negligible.
There are some non-technology companies within the NASDAQ 100 index, including PepsiCo (NASDAQ: PEP), T-Mobile (NASDAQ: TMUS) and Costco (NASDAQ: COST).
5. Financial Select Sector SPDR Fund (NYSEARCA: XLF)
The Financial Select Sector SPDR Fund is a financial sector ETF.
The biggest companies in this ETF are conglomerate Berkshire Hathaway (NYSE: BRK.B) and some of the US’ largest banks such as JP Morgan (NYSE: JPM), Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC).
There are more than 60 companies in this ETF.
The five popular ETFs described above are all passive funds.
The fund managers, SPDR, iShares and Invesco, simply mimic the indices and do little else. This is why the five ETFs have low expense ratios of 0.2% or less.
When the indices make regular changes to their components and weightage, the ETFs will follow accordingly.
Active versus passive funds
Active fund managers pick a portfolio of stocks that they believe can outperform the indices.
In the past three years, the most famous active fund manager is probably Cathie Wood.
Many of her active ETFs have more than doubled in 2020 and 2021 but crashed back to earth last year.
Active funds’ expense ratios are higher than passive funds as they need to spend on research and trade actively.
Do they perform better in general? The answer is no.
Many academic studies have shown active funds perform worse than passive funds in the long run.
Yes, some active funds do perform better than passive funds, but usually the outperformance does not last. Cathie Wood is a good example.
Just like companies, not all ETFs pay dividends.
The SPDR Dow Jones Industrial Average ETF pays dividends monthly while the other four pay them quarterly.
All US-sourced dividends are subjected to a 30% withholding tax for foreign investors, which is deducted upfront.
Get Smart: Collect the information you need
If you are thinking of buying an ETF, search up its basic information including the index the ETF is following, its assets under management, the top 10 holdings, its past performance, the expense ratio and so on.
You can find this information either on the fund manager’s website or aggregator websites such as etf.com or etfdb.com.
If you’re deciding among a few ETFs that seem similar, picking the one with the highest AUM should serve you well.
While the first three ETFs (DIA, SPY and IWM) are broad-based with exposure to many industries, the last two (QQQ and XLF) concentrate on just one industry – technology and financials.
In the long term, all five are positively correlated.
But in the short term, their performance can vary significantly. There are even times when they move in opposite directions.
Which ETF you pick depends on your personal preference.
As an investor, it’s very important that you’re comfortable and confident with your choices.
If you prefer the stability of blue chips, DIA probably suits you better.
But if you believe in technology and are willing to stomach higher volatility for potential higher returns, QQQ could be the ETF for you.
Or, if you really can’t make up your mind, you can always choose to buy more than one ETF, or even all of them.
Disclosure: The author owns shares of Apple and ETFs – SPY and QQQ.