ETF Investing

After you purchase an ETF you will receive a welcome letter in the mail.

Do not ignore this letter!

If you plan on registering for the Vanguard Dividend Reinvestment Plan (or Betashares, or Blackrock – whichever company is offering the ETF you just bought!) you need to follow the steps in the welcome letter. Below is what the Vanguard welcome letter looks like:

The first of these steps is to register your holdings at the share registry.

What is a share registry?

Some people are confused by exactly what a share registry is and what it is used for.

To make it clear I will give an example using something that people are more familiar with – buying a car!

When you buy a car you buy it from a marketplace.

Now the marketplace where you buy the car may be the BMW dealership, it might be Car City, or you might buy from Shane off Gumtree.

Once you own the car the place that you bought it from has no further interest in you. The marketplace’s role in your purchase of the car is finished. But your personal responsibilities regarding the car are not.

What do you have to do after buying a car?

You need to register it.

The places where you can register your car differ by state. Your car registration is held with VicRoads if you live in Victoria, or the Department of Transport & Main Roads if you live in QLD etc.

Wherever you live, these departments play the role of the Car Registry for that particular state.

Your address and contact details are registered with the car registry. And this is how the coppers know where to send you fines when you are caught doing 53km/h in a 50 zone.

Your details are not registered with the place where you bought the car. The marketplace has no interest in you once the car has been sold.

The process is the same when buying shares, you need to register your share holdings with a share registry.

When you buy shares, you also buy them through a marketplace.

With shares the marketplace where transactions take place is called a broker. Examples of brokers are Commsec or NABTrade.

After you have bought shares you need to register your ownership of these shares at the share registry, just as you would register your car at the car registry.

The share registry is the place that holds your address and contact details. This is how the company or ETF that you own shares in knows how to communicate with you.

Now on to how to register your shares with a share registry.

Register your ETF shares at the share registry

There are several share registries that public companies can use in Australia. The two leading share registries are:

• Computershare
• Link Market Services

For all you Vanguard buyers, the Vanguard share registry is Computershare. You will need to log in to the Computershare registry to enroll in the Vanguard Dividend Reinvestment Plan (DRP).

If you aren’t sure which registry the company you own is using, just wait until you receive the welcome letter. This will tell you which share registry to use.

After you have purchased your ETF go ahead and follow the instructions in your welcome letter to register an account with the relevant share registry.

During registration the share registry is going to want you to provide some additional information regarding your share holdings:

Your payment instructions

This is where you give the details of the bank account where you want any dividends you receive to be deposited. If you don’t want to receive your dividends in your bank account and would prefer to participate in the dividend reinvestment plan, this preference is communicated after you have registered.

Your security holder communication elections

Here you let the share registry know your email address so that you can receive company communications electronically. Alternatively you can choose to receive this information at your mailing address.

Your Tax File Number/Australian Business Number

If you are an Australian Resident it is in your interest to provide your TFN. This is so that the correct withholding tax is applied based on your residency status.

If you do not provide an Australian Tax File Number then your share holdings and any income earned from them will be taxed as if you were a non-resident of Australia (read: taxed very highly!)

Ok now you are registered with the share registry lets look at how to enroll in the dividend reinvestment plan.

Set up the Dividend Reinvestment Plan (DRP)

In this example I will walk through registering for a DRP on Computershare.

The option to register isn’t as obvious as you might think it would be so I will use a few screenshots to show you the way.

First, log in to Computershare

Then go ahead and click on My Portfolio over on the right hand side:

Select the Reinvestment Plans option:

Select the share holding that you want to set up the dividend reinvestment plan for:

Then choose Amend from the Select Action drop down box:

On this screen you can choose your participation level. Select Full Participation to enroll in the Dividend Reinvestment Plan:

After clicking next a couple of times you are now enrolled in the dividend reinvestment plan!

You may receive a letter in the mail confirming your change in reinvestment plan option.

Now the next time that your ETF shares issue a dividend, rather than paying out a cash dividend the company will buy more shares for you at no cost!

Did you find this walkthrough helpful? Is there another ETF process that you need help in understanding?

Let me know using the Contact page

ETF Investment Risk 1: Being Too Conservative

Nobody sets out to lose money investing. But if you aren’t taking any risks with your ETF Investments you can’t expect to make any money either!

Risk and reward are very related when it comes to investing in the market – whether you like it or not!

A portfolio that is too heavily invested in cash or bonds simply isn’t going to bring you significant investment returns. You must take on some investment risk and include growth ETF’s in your portfolio such as:

• VGS – International Shares
• VGE – Developing Market Shares
• IJR – Small Cap Shares

I suggest using an asset allocation of 70% growth, 30% income.

ETF Investment Risk 2: Being Too Aggressive

After almost a decade in a bull market everyone starts to get cocky. Margin loans start being used to buy shares. Credit cards start being used to buy bitcoin. And passive investors start to allocate more of their portfolio to “growth”.

It seems like the good times are never going to end.

But the good times always end.

• Black Monday in 1987
• Dotcom Bubble of the early 2000’s
• Global Financial Crisis of 2007-08

The next stock market crash is always just around the corner.

And stock market crashes always happen when it causes everyone the most pain. Like the month after you decide to increase your asset allocation to 90% growth.

Be smart. Stay the course.

Keep it at 70% growth, 30% income.

ETF Investment Risk 3: Trying to ‘Time the Market’

At some point in everyone’s investment life they look at a chart of the market and think:

“I would have made so much more money if I had just bought the lows and sold the highs”

In their head they are visualizing how easy it is to know when the market has topped or bottomed.

Stop that right now.

I am serious.

If you are good enough to be able to buy the lows and sell the highs, why are you even working? Or reading about ETF Investing Risks?

If you are that good then:

• Quit your job
• Head on down to Cost Converters and take out a personal loan
• Start playing Gordon Gecko for yourself on your CFD account

You should be retired in no time! If you are good that is..

But you aren’t that good. So forget about timing the market

Regular contributions to your investment accounts will pay off over time.

Be the tortoise, not the hare. And leave the market timing to the wannabes.

ETF Investment Risk 4: Paying active fund managers who can’t outperform the index

Speaking of wannabes, let’s talk about Active Fund Managers.

If Active Fund Managers could truly do as they advertise and beat the market. Then it logically follows that they would use this skill for self enrichment.

But rather than actively trading stocks and printing money, Active Fund Managers choose to use other people’s money to invest in the sharemarket.

And they charge them between 1% and 2% for the pleasure.

Why do you think this is?

Well the following report from Standard and Poors analyzed Active Fund Manager’s performance over 15 years and sheds some light on the situation.

Over the 15-year period ending Dec. 2016, 92.15% of large-cap, 95.4% of mid-cap, and 93.21% of small-cap managers trailed their respective benchmarks.

Shocking isn’t it?

The vast majority of Active Fund Manager’s simply cannot beat the market.

Don’t get caught out by these con artists.

Stick with a passively invested ETF Portfolio.

The fees are cheaper and you will earn better returns than with an Active Manager

ETF Investment Risk 5: Counter-party Investment Risk

Counterparty risk is the risk that someone you are doing business with is unable to meet their obligations to you.

An example of counterparty risk is: if a bank was unable to give you cash when you made a withdrawal from an ATM.

Counterparty risk is often viewed as something beyond your control. But there is one step you can take to minimize the ETF investment risk from counterparties.

If the Global Financial Crisis taught us anything it is that not all banks are safe.

It also taught us a new term: Too Big To Fail.

We learned that some financial institutions would simply impact the market too much if they were allowed to go bust. Lehman Brothers was not Too Big To Fail, Bank of America was.

You want to be invested with the Bank of America equivalent in Australia.

And which bank is Too Big To Fail in Australia?

Well the SMH reports the Australian Online Broker Market Share as follows:

• 50% Commsec
• 18% E*Trade
• 8% Westpac
• 7% ANZ
• 5% BellDirect

If anything went wrong, I predict that the government would only step in and save one of these companies.

Just another reason to invest with Commsec.

Sorry to those of you who use offshore operators like SaxoBank and IG Markets. You don’t stand a chance in the event of a crisis.

To properly understand exactly what is an ETF is you need to understand how an Index works and what an Index Fund does.

Let’s look at what an Index is first.

What is an Index?

An index is a way of approximating the value of a country’s share market.

Do these names sound familiar?

• All Ordinaries (aka. The All Ords)
• S&P 500
• Nikkei
• Hang Seng
• FTSE (pronounced foot-see)

These are all examples of Indexes. You can hear the value of these Indexes being reported each night on the evening news.

These Indexes are used to track the value of different country’s stock markets:

• The All Ordinaries Index tracks the top 500 stocks in Australia
• The S&P500 Index tracks the top 500 stocks in the USA
• The Nikkei Index tracks the top 225 stocks in Japan
• The Hang Seng Index tracks the top 50 stocks in Hong Kong
• The FTSE100 Index tracks the top 100 stocks in the UK

Back in the day it was difficult to track the value of an entire country’s stock market. For example, the Australian Stock Exchange (ASX) has over 2,000+ stocks listed. To know the value of the entire ASX would require you to know the price of every stock on the market.

And you would need to perform this calculation every single day if you wanted to know the daily value of the share market.

Indexes simplified this problem by providing an approximation of the total stock market value using only the top 30-500 stocks on the market rather than thousands of stocks.

An Index is just a list of stocks (or bonds, or sheep, or cars. ANYTHING can be an index).

But you can’t buy an Index.

An Index simply tracks the value of a portfolio of things.

What if you wanted an easy way to buy the Index?

How can you easily invest in all the companies tracked by an Index?

That’s where Index Funds come in.

 

What is an Index Fund?

An Index Fund is a managed fund that invests in the portfolio of shares that are tracked by an Index.

The companies that produce indexes such as MSCI  are not involved in buying and selling shares. They simply calculate the values of indexes based on the current price of the shares in that index.

Companies such as Vanguard are fund managers who’s job is to continuously buy and sell all the shares tracked by the index in an effort to replicate the performance of the index.

If you want to invest in an Index Fund you need to contact a fund manager like Vanguard or Blackrock, open an account with them, and invest your money into their index funds.

Investing in managed funds this way was how it worked for years.

Until the ETF revolution began.

But what is an ETF?

 

What is an ETF?

ETF stands for Exchange Traded Fund.

ETF’s allow you to invest in an Index Fund without having to deal with the fund manager directly.

Because they trade on the stock exchange, ETF’s can be bought and sold in the same way you would invest in any other company.

This means that you can buy ETF’s through your online broker anytime the stock market is open.

With Index Funds you have to deal directly with your fund manager. Fund managers typically require minimum account values in order to talk to them. Fund managers charge you fees to buy and sell their index funds. You can see where I am going, Fund Managers are a pain.

ETF’s remove all those complications and make the process much simpler and cheaper.

Just login to your brokerage account and click buy or sell.

This is why ETF’s are predicted to make up 50% of the US stock market value by 2024.

Let’s recap:

• An Index tracks the value of a portfolio of shares
• An Index Fund invests in the portfolio of shares that the Index tracks
• An ETF is an Index Fund that is publicly traded on the stock market

Now that we understand what an ETF is, let’s take a look at how to buy an ETF in Australia.