Some of the most popular videos on my channel are ETF reviews, with some of the stand outs
being QYLD, NUSI and dividend ETFs.
For reasons I will explain at the end of this video, I will no longer be doing videos like
these.
But, given that people request these kinds of topics all the time, I didn’t want to
move on before leaving behind a resource to replace them.
So in this video, I’m going to show you how I analyze an ETF and decide whether I
want to invest in it.
My goal is to explain where to find all the information needed, as well as the exact thought
process I use to comprehend these funds.
Afterwards, you should be able to repeat this process with any investment fund and make
more informed decisions.
We’re breaking it down into 6 steps: first is identifying the fund’s objective and
looking at its stats.
Then, diving deeper into the funds strategy.
Next, I like to get more context by examining the fund’s portfolio.
If it’s a dividend or income focused fund, we’ll also have to examine the fund’s
dividends.
Lastly, after understanding all this information, we can compare it to investment alternatives
and finally make a decision on whether to initiate an investment.
To help you follow along, we’ll be completing all the steps along the way with Vanguard’s
High Yield Dividend ETF, ticker VYM.
And as mentioned, I’ll wrap things up with why I’m discontinuing these ETF review videos,
so let’s get moving.
The first step I always take when approaching a new ETF is figuring out its objective and
taking a look at its key stats.
You can probably find this information in a few places, but I prefer to go directly
to the fund provider’s website to get the latest information.
So let’s give it a go with VYM.
Most fund providers offer an overview section similar to this one, where we find most of
what we need.
The objective is usually front and center - in this case, it’s to track the performance
of the FTSE high dividend yield index.
Since it’s tracking an index, it’s no surprise that this is a passively managed
fund.
So with this, we’ve already answered two key questions I ask myself.
First, what’s the goal?
In this case, the goal is investing in domestic, high-yield dividend stocks.
This is most likely going to accomplish a higher dividend yield with the potential for
capital appreciation, although the priority is clearly dividends.
Therefore, we know this is a potential fit for dividend growth investing or any other
dividend-focused strategy.
We also know it is a passive strategy, which is the second thing I like to identify from
the beginning.
An active strategy requires a much more critical look, so I like to brace myself for that early
on.
During this step, I also like to identify the expense ratio.
I personally rule out any portfolio with fees over 1%, and anything above .5% will have
to really impress me elsewhere in order to win me over.
Ultimately, this comes down to the fact that I just want to pay as little as possible for
my investment, and larger fees can add up over time.
With VYM, we have just .06%, which is right on-brand for Vanguard and perfectly acceptable
to me.
The last things I consider during this stage is the price chart and dividend yield.
At a glance, I want to be able to tell that the ETF’s price is growing over time, and
the dividend yield gives us some extra context on our expected returns and may further indicate
what kind of strategy the fund is aiming for.
There are some yield-oriented strategies that may be designed to generate dividends without
price appreciation, so that is something to consider if you’re looking for that kind
of strategy.
However, a declining price chart, or one that significantly lags the market, is an immediate
red flag for me.
Again, we’re good to go here with VYM, and the dividend yield of just under 3% verifies
what we interpreted from the fund’s objective.
So this is the quick “at a glance” analysis I do for most ETFs when someone is like “hey,
check out this ETF, what do you think?”.
These details tell me if there’s anything worth exploring further.
But, you’ve always gotta dig deeper before initiating an investment, and that takes us
to the next step.
And that is diving deeper into the fund’s strategy or methodology so that we can really
understand how things work behind the scenes.
During this stage, I want to answer the following questions: first, what is their stock selection
process?
In other words, how do they sift through stocks and decide what is going to be included in
the fund?
Next, how do they decide how much to allocate to each holding?
Is it something like market cap weighted, or is it up to the fund managers?
I also want to understand any other strategies at play, whether the fund employs options,
leverage or anything else beyond just holding stocks.
My goal in answering the questions is simply to understand how the fund works.
By understanding the methodology behind the fund, I can determine whether it aligns with
my own beliefs and therefore if it will fit in my portfolio.
If you don’t understand how it works, you’re likely to make investing decisions based on
the wrong information, which could lead to poor returns.
Luckily, every fund I’ve seen provides answers to all of these questions in really thorough
detail.
The trick is navigating all of the financial jargon and identifying the most important
parts.
The first place I recommend starting is the fund’s fact sheet, which is typically found
on the fund’s website.
Most websites will have this and all other documentation under a “fund literature”
or “documents” section.
The fact sheet is usually 2 pages and gives condensed overview of the fund, as you can
see by this one on VYM.
In this case, we see again that VYM is entirely passive and replicates the index it seeks
to track, which is the FTSE high dividend yield index.
They also give us a hint that it emphasizes higher yielding stocks, so will probably weigh
stocks heavier based on their dividend yield - with some additional details below.
This still isn’t enough to answer all my questions, so we have to take another step
further, which will vary depending on the type of fund.
Most passively managed funds are designed to track an index, just like VYM.
In this case, Vanguard isn’t doing any original strategies or methodologies - they’re just
copying the one outlined by the FTSE high yield index.
If you are researching a passive fund like this, the best thing to do here is to refer
to the website of that particular index, where the methodology will be outlined in greater
detail.
Unfortunately, I looked everywhere and couldn’t find anything about this high yield index
on FTSEs website - only their global dividend strategy and a us-based dividend growth strategy.
I then found an old Seeking Alpha post that says the US high dividend index was proprietary,
and therefore may not be publicly available to review.
This is really frustrating, and would honestly be a red flag for me.
But, I think this is also a good learning experience because you may encounter the same
thing during your research.
In this case, we’ll do our best to keep digging elsewhere and make a decision based
on the information we do have.
So I found another article on seeking alpha that said the fund is market cap weighted,
and a breakdown on ETF.com that says the same thing.
My educated guess at this point is that they rank all stocks by dividend yield, or maybe
set a minimum dividend yield, then choose all stocks over a certain market capitalization
and weigh them based upon that market capitalization.
More on VYM in just a minute.
The other step you take is if you have an actively managed fund, which will not have
the cut and dry methodology of an index.
So instead of referring to an index provider, you’ll want to check out the fund’s prospectus
documents, which again, can be easily located on the website.
These documents are long and dense, but you just need to find the section on “principal
investing strategies”.
Here, fund providers outline all of the strategies that go into managing the portfolio, and it
should be able to clear up most of the methodology behind the fund.
If it seems like the fund managers have a really concrete ruleset for managing the portfolio,
you may be able to move onto the next step.
But if it seems like they have a lot of room to deviate from their strategy and manage
the portfolio however they like, you may want to dig deeper into the management team or
the investment firm.
This will give you a better idea of the beliefs that drive their investment decisions, which
may not be clearly described within fund documents.
After these steps, you should understand the passive or active decision making that determines
a fund’s makeup.
Next, I like to take a look at the fund’s portfolio to ensure it aligns with all the
previous information, and to understand what the strategy actually looks like under the
hood.
Again, this should be pretty front-and-center on the fund’s website.
I like to specifically look for details surrounding diversification, like the top 10 holdings,
geographic diversification, market cap diversification, and sector diversification.
My goal here is to identify how any overweight or underweight components could impact the
portfolio when it comes to risk.
For example, do I see too much weight in a specific sector or a strange weighting to
a specific country?
By understanding the weaknesses or strategic overweightings in the portfolio, I can understand
the risks involved and how it could impact my overall investing portfolio.
In most of these cases, I use the S&P 500 for my comparisons, since it is arguably the
benchmark of all benchmarks when it comes to market diversification.
With VYM, this step will give us more context into the strategy since we weren’t able
to identify a specific methodology for the index.
Using ETF.com, we can get an easy comparison to the S&P 500.
We can see that VYM is actually pretty similarly diversified to the S&P 500, with the exception
of a massive underweighting in tech, which is to be expected, as they are not typically
dividend paying companies and this is a dividend focused fund.
The top 10 holdings are also weighted similarly to the S&P 500, so it doesn’t appear to
be drastically top-heavy.
It’s also clearly focused on large cap stocks.
This tells me that the methodology behind VYM probably isn’t much different from a
standard total market, market cap-weighted strategy.
I’m guessing they just have a minimum dividend yield requirement for their holdings, and
accept most candidates without any other constraints.
Since the dividend yield is pretty average, I don’t think they’re emphasizing or overweighting
high yield stocks as much as their fact sheet suggested.
The next step for any dividend-focused strategy is going to be taking closer look at the dividends
themselves, which is important for a lot of reasons.
For starters, we want to identify the tax treatment of the dividends.
If you’re looking to hold an ETF within a tax-sheltered retirement account, you can
usually skip this step.
But if not, you need to determine if you’ll earn qualified dividends from the fund, because
you’ll get to keep more of your dividend returns with their long-term capital gains
tax rate.
Most funds will have tax information documents with the rest of the fund literature, so it
shouldn’t be too hard to find.
Others, like Vanguard, will have all of their funds’ tax information in a single place,
which may require some more digging.
Here, we can see that VYM is almost entirely qualified dividend income, which is a great
sign.
Next is to check for return of capital.
This is when the fund pays out a dividend that contains your initial principal, and
doesn’t actually come from the fund’s investment returns.
Sometimes this can be a clever way to give you a tax break, other times it can be a red
flag that the fund isn’t earning enough to pay your distributions.
A quick rule of thumb is that if the fund is continuing to grow its NAV, return of capital
is safe, and you can learn more about that in my video on the subject.
This information should also be available in the tax documentation, but you won’t
have to worry about this with plain, passively managed index funds.
Next, you’ll want to check the dividend history to get a pulse on any dividend trends.
Whether it’s increasing, dividends have been cut or missed, or even if its been consistent
for years will all give you more context on what you can expect from the investment.
I like to use seeking alpha for this as they put the information into bar charts that you
can easily identify patterns in.
Finally, for any active strategy that generates income from sources besides dividend stocks,
you may want to look at their income sources.
For example, strategies that combine dividend stocks and covered calls will earn income
from both sources, and pass a mix of returns those returns to you.
It’s important to figure out the makeup of your dividend so you can understand how
market trends will impact that dividend income.
This is one of the tougher things to find, as you’ll have to dig into the funds’
annual reports.
Once you’re there, you’ll have to find the statements of operations, which will breakdown
the fund’s sources of income.
Dividend income is obviously dividends from stocks, interest income comes from other investment
vehicles, and you also have things like selling options as another source of income.
Understanding all of the fund’s income components and how large they are will give you a better
picture of what to expect from the fund in the future.
Finally, we’ve completed all of the analysis needed to take one of the final steps, which
is comparing a given fund to any alternatives.
The goal here is to determine if this fund is the best option within its peer group for
achieving its objective.
Performing this step could vary quite a bit depending on the fund you’re looking at
and what the alternatives are.
For example, there are countless dividend ETFs out there, so we could get really deep
with comparing VYM to other dividend ETFs.
In these cases, I would consider the total returns, dividend yield, any differences in
strategy or methodology, and portfolio diversification.
This may also require repeating some of our analysis again with other ETFs so we can get
a clear comparison.
And again, there are really a lot of different ways to approach this diversification, so
you’ll really have to identify the details that are most important to you and assess
your options accordingly.
Regardless of the fund, I also like to check back with the S&P 500 again in terms of total
long-term returns.
This may not be necessary if you are strictly looking for income or for more complex strategies,
but I always find that the historic performance of the S&P 500 puts things in perspective.
It’s the benchmark for stock market performance for a reason, and it’s a good reminder not
to overcomplicate things when you could do just fine with a simple total market fund.
To continue our VYM analysis, we can see that it has underperformed both VOO and VTI, but
mostly in recent years due to the outperformance of growth stocks.
I like that it’s well diversified and mostly tracks the market, but if I was looking for
yield, I know there are better options elsewhere.
For total returns, I’m better off with total market funds.
So to me, although I am fairly biased against dividend strategies, it doesn’t make sense
to sacrifice both yield and total returns for this dividend fund.
In other cases though, after passing the comparison test, it’s time to make a final conclusion
on the analyzed ETF.
At this point, I just ask myself a few final questions before moving forward with an investment
decision.
First, does it align with my investment goals?
With VYM, this was a no, because I don’t follow a dividend or income strategy.
It doesn’t make sense for me to invest here.
Next, do I have a full understanding of the fund?
If I don’t see full transparency from the documentation or I can’t wrap my head around
the strategy, I won’t move forward.
VYM almost failed here due to the lack of accessibility to the index’s methodology,
but given that it’s a passive indexed strategy, I think I have enough here if it checked all
my other boxes.
Next is do I trust that the fund will continue to deliver on its objective?
Whether that’s growth, reliable dividend income, low volatility or whatever it may
be, this is a great time to look at the big picture and consider if you’ll get what
you want out of the fund.
Plus, what the risk could look like if you don’t.
If I have the right answers to these questions, I generally feel comfortable adding an ETF
to my portfolio and adjusting my allocations accordingly.
So I really hope this gave you some good tips and strategies for analyzing ETFs on your
own, and as always I’m happy to expand further or answer any questions in the comments below.
But for those who have been following my videos and have become fans of my ETF reviews, you
may still be wondering why I no longer plan to do them.
To keep things as concise as possible, I never intended to create an ETF review channel.
I have huge appreciation for the support I’ve gotten around them, and I’m really glad
I was able to provide some value with each of those videos.
But, there are things that I want to discuss other than dividend ETFs.
My interests include cryptocurrency, credit cards, self-employment, making money online
and so many other areas of finance.
Furthermore, I don’t even follow a dividend strategy or have interest in the funds that
I’ve been reviewing, and I think I can be more valuable to you by sharing things that
I’m personally pursuing and have experience with.
A lot of this also goes hand in hand with my epiphany that I don’t want to be an active
investor.
I want to enjoy building wealth without pouring hours of research and market activity into
it, so it makes sense to take a break from these topics for now.
I explained all of my thoughts in this video right here, so be sure to check that out for
more on my current mindset surrounding stock market investing.
Thanks for sticking around and I’ll see you in an