What To Research Before Buying An ETF
The Dynamic Wealth Report
December 31, 2008
Best Of DWR: Dump This ETF NOW!
Editor's Note: The research team at Hyperion Financial
Group has been working tirelessly all year to bring you great investment
ideas. Some of our ideas worked better than others. Sometimes we were on
the mark, sometimes we missed a bit. Either way, we’re constantly
striving to bring you original money making ideas in some of the
toughest market environments. Here’s a highlight from this year….
Originally published in the September 12 edition of
The Dynamic Wealth Report…
Dump This ETF NOW!
I read the Wall Street Journal every day. I have for years. It’s the one
publication that every professional investor I know reads regularly.
Reading the Journal has become a habit for me. I start off every day
getting up to speed on all the important business news.
But the Journal’s not alone.
There’s a handful of other magazines and newsletters I read also. It’s
amazing the amount of information I can devour over the course of a
week. Often times you’ll get the best investment ideas from the
strangest places.
As a matter of fact, just this week I found something really interesting... An ETF you shouldn’t buy (and I’d actually sell it if I owned it).
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I know it’s strange. I’m always talking about how great ETFs are. I’m
always going on and on about their low cost, instant diversification,
and the way they make playing trends easy. I like ETFs so much, they
make up the majority of my retirement account.
But then I found an ETF you shouldn’t buy.
And if you own it, I’d consider selling it.
I’ll tell you why in a moment. But first let me tell you how I found
this horrible ETF.
Like I said, I love to read the Wall Street Journal. They’ve got tons of
information on individual companies, industries, and the market in
general. In the Money & Investing section they publish a boatload of
data. So much so, I normally ignore it. It can be quite overwhelming. If
you read the Journal, I’m sure you know what I mean.
Anyway, earlier this week I was studying some tables of information.
One area that caught my eye was the high yield list. Capturing a good
yield on a stock is never a bad idea (or so I thought).
I couldn’t believe what I found. Smack dab at the top of the list. An
ETF yielding 17.49%. Let me tell you, I got really excited. But I knew I
had to do some research.
The first thing I did was verify the yield. Normally you can trust the
data in the Journal, but it never hurts to double check. Nobody’s
perfect, and mistakes do happen. Sure enough the data was wrong.
I looked on Yahoo. They listed their last dividend payment as late 2007.
I knew that couldn’t be right. So I went right to the source. I visited
the fund website. There I could download the ETFs historical prices and
dividend table. The last dividend paid (last quarter) was $0.75. So a
little quick math - $0.75 times 4 is an annual dividend of $3.
The ETFs trading at $20 per share. So that makes the dividend yield
closer to 15%.
Not quite the 17.5% I was expecting, but a good number nonetheless.
So I researched this ETF a little further. The size of the fund was
small ($28 million in assets) but I’ve seen smaller. And for a big
yield, I’m willing to let that issue slide. The liquidity on the fund
was “OK”. It traded around 25,000 shares a day. Not great, but I wasn’t
going to be buying a huge number of shares – at least not right away.
Then I checked out the management fee, a respectable 0.48%.
So far so good. Just a few more things to research.
The next step was looking at the ETF holdings. The fund held 23
different securities. Again, not great, but I could live with it. I
normally like to see at least 20 companies for good diversification. As
I reviewed the holdings, it dawned on me why the yield was so high. Most
of the companies were in the mortgage finance industry.
That was the first red flag.
I was still salivating over that 15% yield. So I was willing to take on
the risk of investing in a downtrodden industry. So I continued my
research. That’s when I discovered the facts that turned my stomach. It
was just a little number.
But it told me flat out – don’t buy this ETF.
What was it?
It was the percentage holdings. I like ETFs because of their
diversification. This fund’s top two holdings (YES just 2 companies)
accounted for more than 40% of the fund’s assets. It kind of defeats the
purpose of being diversified, don’t you think?
If I wanted to put half of my money into two stocks I’d go out and buy
those stocks... why buy the ETF at all? Definitely a red flag, and a
big one at that. It told me to stay away! The risk was too great.
So what ETF was I researching? It was the iShares FTSE NAREIT Mortgage
REITs (REM). Despite its high yield, I’d stay away from this ETF. Its
holdings are too concentrated. If one of those two top holdings hits a
rough patch, you can kiss your investment goodbye. By the way, if you
hold this ETF you might consider selling it.
• Gold ($0.85 per pound)
Gold’s had a wild ride this year. The first half was spent
climbing to record highs over $1,000 an oz. Then it collapsed falling
below $700 an oz in late October. Now we’re seeing Gold rally again on
global recession fears. I think this is one commodity setting up for an
exciting 2009.
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