There's something putting the spring in the step of employees all over the country - and it's not the weather. It's bonus season. According to the Office for National Statistics, the average bonus received by an employee was £1,400 in 2012-13, and as the economy is improving, pay and bonuses are rising. For young investors or those putting away small amounts of money, getting a bonus could be a rare opportunity to do something a bit different with a lump sum investment, rather than drip-feeding into funds every month.
One idea to consider is buying a portfolio of exchange traded funds (ETFs), a super-cheap way to get exposure to stock markets all over the world. They are not suitable for a regular investor because they are traded as shares and therefore incur nasty platform dealing costs if you accumulate them gradually. The best way to buy them is with a one-off lump sum, and here we show you how to do it.
What is an ETF?
Exchange traded funds are a relatively new type of mutual fund that aims to follow the performance of an index such as the FTSE 100. They offer low-cost (fees range from less than 0.1 per cent to 1 per cent) access to virtually every corner of the market. They are pooled investment vehicles that can invest in stocks, bonds, commodities, currencies, options or a blend of assets. Investors buy shares, which mean they own a proportional chunk of the pooled assets. ETFs allow investors with virtually any amount of money to build diverse portfolios with lower costs and better transparency than traditional investments.
You buy shares in an ETF directly from any broker account in the same way as you buy shares in a stock. Because they are exchange-traded, you can buy them at any point in the trading day - unlike traditional mutual funds which can be processed only once per day. If you wanted, you could buy shares in the morning and sell them in the afternoon.
Do I need a special ETF strategy?
The most important thing to remember is diversify your investments - making sure you have varied exposure to different asset classes (equities, bonds, etc), regions and types of company and strategy. As long as you've achieved this, keeping things as simple as possible is a smart idea according to Alan Miller, director at SVM Private, especially if you're new to ETF investing.
The exposures you decide to buy through ETFs will depend on what you've already got in your investment portfolio - if you have one. There is a vast selection of ETFs to choose from, but examples of core holdings for beginner investors are UK, US, Global, Emerging Markets and Bond ETFs. However, if you've already got a FTSE All-Share tracker fund, for example, there's little point in buying an ETF that follows the same index.
A major temptation for newbie ETF investors is to try and time a market by throwing a wad of money into it and hoping it will soar in value, at which point you can sell and then count your winnings. But Shaun Port, head of investments at Nutmeg, says this is a highly risky strategy that only seasoned investors should try. Beginners should also avoid leveraged ETFs, because although they can boost your returns if your ETF makes money, the effect they have when it loses value can be devastating.
I've heard ETFs are a cheap way to get commodity exposure, should I use them to diversify my portfolio?
Commodity ETFs and exchange traded commodity funds (ETCs) can be a cost-effective way to get exposure to commodities such as precious metals, oil and agricultural produce. But they are highly risky and not something to consider unless you already have a strong core portfolio of investments.
Experienced investors tend to buy ETCs for a short-term hold - which could mean they end up selling it after a few days or weeks. But Mr Miller warns: "Trying to predict commodity prices is more difficult than trying to predict the weather." Before you jump in, be aware that commodities can have years in which the price slumps - meaning even adventurous investors shouldn't give more than 5 to 10 per cent of their portfolio in them.
If you are keen on taking a punt on commodities, try db x-tracker's DBLCI OY Balanced Ucits ETF (XDBG). It invests in a wide basket of commodities (which dilutes the risk), including WTI Crude Oil, Brent Crude Oil, Heating Oil, RBOB Gasoline, Natural Gas, Gold, Silver, Aluminium, Zinc, Copper, Corn, Wheat, Soybeans and Sugar. It has a net expense ratio of 0.55 per cent.
Keep investing nice and cheap
ETFs are a great way to keep the cost of investing down, but costs do vary widely, so make sure you don't pay more than you have to. Mr Port says you shouldn't pay more than around 0.4 per cent in fees unless you're buying an esoteric investment such as an emerging market ETF. Avoid US-listed ETFs like the plague - as they come with extortionate foreign exchange tax charges of up to 1.7 per cent a year - and you'll have to fill in an annoying form. And remember to buy ETFs in your stocks & shares Isa so you don't have to pay tax on your returns.
Core ETFs for your portfolio
UK
iShares FTSE 100 UCITS ETF (Acc)(CUKX) aims to follow the performance of the FTSE 100 index, and it reinvests the dividends for you, all for the price of 0.15 per cent. Don't confuse it with the similar-sounding iShares FTSE 100 dividend-paying ETF (ISF), which is much more expensive at 0.4 per cent.
Bonds
If your risk appetite is conservative, take a look at PIMCO's Sterling Short Maturity Source ETF (QUID). It's a very short-term bond fund that seeks to maximise income while preserving capital. It's relatively cheap with a TER of 0.35 per cent.
US
If you're investing in the US, the SPDR S&P 500 ETF (SPX5) comes highly recommended. It tracks the S&P 500 index and has a very competitive total expense ratio (TER) of just 15 basis points a year. iShares S&P 500 Index Fund (IUSA) is more expensive, charging 40 basis points per year.
Global
Powershares FTSE RAFI All World 3000 UCITS ETF (PSRW) will inject a higher level of risk into your portfolio. It will give you a broad selection of stocks in both the developed market and the emerging markets, focusing on stocks it perceives as being inexpensive. Powershares invests in an index put together by FTSE and RAFI that focuses on companies' economics and disregards their stock market value, so it can find cheap stocks. It has a TER of 0.5 per cent, which is reasonable considering it invests in emerging markets.
