Investing 101: Basics of Investing

I was explaining to a new client recently how we invest our client assets. They wanted to know if we use individual stocks, Mutual Funds or ETFs (Exchanged Traded Funds.) I told them we don’t use individual stocks or securities, as this adds a level of risk that does not necessarily improve the risk/reward return. The best way to explain this is to look how a dollar gets invested. Say you have 1,000 dollars you want to invest. You could buy APPL today which is $267.17 a share, and you get approximately 3 shares or you could buy an S&P 500 ETF and get diversified through all of the company’s invested in through the ETF. One such ETF is SPTM: today’s price is $38.91 a share and has 2,849 holdings of which APPL is the top holding. The same $1,000 buys you approximately 25 shares of the ETF. We know that APPL has done well over the last few years, but what if you decided to buy GE instead? You would have seen your investment drop from a high in December 2016, from $30.38, to $10.98 a share today. Some firms buy stocks that will mirror an index and then charge their clients a higher fee for the additional cost for trading and research. If you did a risk/reward review of that style, you could find that a better option would have been to diversify using ETFs and Mutual Funds.

Our conversation moved to the question: which is better ETFs or Mutual Funds? I find that both have a part to play when you look to build a well-diversified portfolio with an efficient risk/reward profile. If you are going to buy the general market, then an ETF is a better option than a Mutual Fund for that space. Here it is harder for an active manager to outperform an index ETF. The internal cost of a mutual fund is higher than an ETF, so you need to be strategic on where you want to spend the money to hire an active manger. I find the best space for active management is where the active manager can leverage their company research and add the most value over time. One thing most people don’t realize is that all ETFs are not alike. The actual security selection that is in an ETF is determined by the company that sponsors the ETF. Are we looking at an S&P 500 Index or a Russell 1000 Index? Did they use CAP Weighting or Equal-Weighting for the same index? Once you start looking behind the curtain you might be surprised by what you find.

We ended our conversation discussing value-based investing. They wanted to know whether if they wanted to avoid a certain type of investment, we could manage that for them. I told them that we could and have a long history of values-based investing. Some would refer this type of investing to SRI (Socially Responsible Investing) or ESG (Environmental, Social, Governance.) There are a number of other views and newer terms that are being added. The idea is that you place screens on your investment selection to keep out the investments you want to avoid. Some would also add an investor advocacy to promote the views they have. Since we have been active investors in this area, we can help our clients navigate all the choices the markets provide. The first place to start is to understand what you want to avoid. Remember this investment style removes companies from the investable universe based on what they do, or other criteria determined by the sponsor of the mutual fund or ETF. There is no clear determination of what is good or permitted in the investment, or what is bad or excluded from the security selection. One great example is alcohol and tobacco. Some may say no to both while other would say no to tobacco but alcohol would be ok. You need to understand how each company looks at the investing universe to know what you are giving up, and how it matches your value-based investing goals. Just like we have different church denominations, each sponsor company views the investable universe through its own values and beliefs. You will even find that certain companies have the same ideology but then shift to a different view on how they reach their goal. We can find churches in the same denomination that will have a more conservative or liberal view than others, so you can find values-based investing firms have different views on the same topic. Understanding what you’re investing in or avoiding is important.

The big picture is that we will guide you through all of this by asking some simple questions. After clarifying a few points we will then explain what options best match your needs based on our conversation. We will then check in from time to time to make sure we continue to model your investments on your values.