By now, you’ve probably heard a lot about exchange-traded funds (ETFs). Since their inception in the early 1990s, the financial world has been aflutter with investors hungry for the efficiency and ease of buying ETFs. Want to know how you can cash in on the ETF craze? Here’s a look at exchange-traded funds…

If you’re wondering what an ETF is, you’re not alone. ETFs are portfolios that you can buy and sell ownership in. Basically, an ETF is a lot like a mutual fund that trades on an exchange like a regular stock. That’s an important distinction, because unlike open-ended funds, which buy back their own shares, ETF owners can sell their funds to anyone in the stock market who’s willing to buy. That and higher levels of transparency make for an investment that trades much closer to its actual value than a regular mutual fund.

Advantages of ETFs

There are a few reasons why ETFs look good… ETFs offer instant diversification, lower costs, and ease of purchase that you can’t find anywhere else.

As an investor, one of the smartest things you can do with your portfolio is diversify. That’s because a diversified portfolio can make more gains at a lower risk than a single investment. Since ETFs own a bunch of different securities (like stocks and bonds), when you buy an exchange-traded fund your portfolio is instantly diversified.

Besides diversification, one of the biggest reasons to get into an ETF is cost. For starters, ETFs can substantially reduce the transaction costs associated with diversification. Instead of paying commissions for each individual stock you buy to diversify your portfolio, when you buy an ETF, you only pay commissions for the ETF itself. ETFs also have considerably lower expense ratios than mutual funds.

Expense ratios are the management fees funds charge to their investors. With an ETF, expense ratios are generally between 0.1% and 1% — compare that to the 1% to 3% generally charged by mutual funds, and it’s clear that ETFs are the winner here.

One of the reasons ETFs have been so successful is their accessibility. ETFs trade on stock exchanges, which means that any investor has access to them without minimum investments restrictions. That means that they’re the easiest way to get into a managed fund investment.

Kinds of ETFs Available

Today, new types of ETFs are springing up, giving individual investors more investment options than ever before. Here are some of the main types of ETFs:

Stock Index ETFs: The most common type of ETF today. These funds are designed to track major stock indexes like the S&P 500 or the Dow Jones Industrial Average. In fact, the most popular ETF of all-time, Standard & Poor’s Depositary Receipts (SPY: AMEX), is an ETF that tracks the performance of the S&P 500.

Bond funds: Another type of investment represented by ETFs. Funds like the iShares Lehman Inter Govt/Credit Bond ETF (GVI: NYSE) aim to match Lehman Bros. bond indices (which continue to operate under Barclays ownership).

Commodities ETFs: A category of exchange-traded fund that has popped onto the scene recently. Commodities — like oil, gas, grains, and gold — were once a tougher market to get into for small investors. Now commodities plays like the U.S. Oil Fund (USO: AMEX), which significantly outperformed the S&P 500 in 2008, are showing the financial world that opportunities abound in the ETF world.

Managed ETFs: In 2008, the Securities and Exchange Commission decided to allow actively managed ETFs for the first time, meaning that ETFs weren’t relegated to tracking an index or commodity. The first group of actively managed ETFs was put out by PowerShares in July 2008.

Finding Small-Cap ETFs

As a penny stock investor, small-cap ETFs are a very interesting idea. There are a number of index ETFs that invest in small-cap plays, including the iShares Russell 2000 Index ETF (IWM: NYSE), the Vanguard Small-Cap ETF (VB: AMEX), and the iShares Morningstar Small Core ETF (JKJ: NYSE).

We’ll continue to pour through the hundreds of different funds available to small-cap investors. We’ll let you know when we find something worth investing in. Until then, be sure a keep an eye out for an upcoming opportunity called Retirement: Plan B, which will focus on investments such as these.

Cheers,
Jonas Elmerraji

October 30, 2008

Small-Cap Investor’s Guide to Exchange-Traded Funds (ETFs) was originally featured in the Penny Sleuth.

The problem is penny stocks are a bit more difficult to research than their large blue chip cousins. To make this a bit simpler for first-time investors, here are the top ten things to keep in mind when looking for solid penny stock plays:

10. Think Outside the Box

When it comes to penny stocks, some of the wackiest ideas have translated into serious gains for investors who were willing to think outside the box…

Back in the day, who would’ve thought that computers were the “wave of the future”? Early investors in companies like Microsoft and Yahoo, that’s who! They made a bundle by thinking outside the box and betting on business models and technologies that were out of the ordinary.

There are new technologies and business models out there in the penny stock world today. Are you willing to think outside the box on your next penny investment?

9. Know What You Own

In the world of Wall Street, whether you’re investing in penny stocks or blue chips, one of the biggest rules is to “know what you own.” What does that mean?

You should know the company you’re investing in inside and out. Know its business. Know how it makes money. Know its management.

But as important as this rule is for any investor, it’s doubly important for investors in penny stocks! That’s because with penny stocks, share prices can change quickly if you don’t keep a handle on them.

So know what you own and your investments won’t end up owning you.

8. Don’t Get in Over Your Head

When you see a hot penny stock that’s ready to take off, it can be hard to keep from cashing out your 401(k) to buy as many shares as you can…getting in over your head with penny stocks is an almost sure way to get burned.

Even though penny stocks can make you some serious money, they’re volatile — and that means you shouldn’t put more than 10% of your portfolio on the line.

What’s the smart penny investor to do? Set up an account for just penny stocks and load it only with money you’re prepared to lose.

7. Don’t Be Afraid to Ask…

One of the beauties of penny stocks is the fact that they’re smaller companies that are out there for smaller investors.

As an individual investor, a big multinational might not give you the time of day. That’s usually not the case with penny stocks. In fact, it’s not unheard-of for individual investors to pick up the phone and chat with a company’s CEO or CFO on the spot.

If you’ve got a burning question about a penny stock prospect, e-mailing or calling the company’s investment relations firm or corporate offices might be one of the most telling ways to figure out if that stock’s for you.

6. Be a Skeptic

Remember when we said to think outside the box? Well, do that, but don’t forget to be a skeptic…

Just because a company has an interesting new idea doesn’t necessarily mean it’s a good prospect for your portfolio. The key is…Do you think that it can monetize its idea?

If that answer isn’t immediately clear, it’s time to dig a little deeper into that company’s prospects. Thinking outside the box is a great way to get innovative companies on your radar, but being a skeptic is the only way to make sure that translates into gains for your portfolio.

5. Think, Then Buy

When you’re ready to buy shares of a penny stock, make sure you take a second to think about what you’re doing. All too many first-time penny investors take the jump on just a few shares of a penny stock without realizing how much the size of their investment will affect their returns.

Think about it this way… You’re an investor who sees an attractive stock for $1 per share. You don’t have a large portfolio yet, and you don’t want to take too much of a risk, so you buy just 50 shares for $50.

Turns out you picked a winner that made 40% in just a week — $20 of pure profit. You sell and rejoice in your penny stock success. But wait…is that celebration justified?

You’re forgetting about those $10 execution fees you paid to buy and sell that stock. That’s $20 altogether. Looks like you only broke even, despite the fact that you had a stellar stock.

When you’re buying penny stocks, make sure you’re buying a large enough quantity that account costs (like execution fees) don’t eat up your profits. You can find out your minimum returns to break even with this:

Execution Fees/Stock Acquisition Price x 100 = Break-even Gain (Percent) Needed

4. Don’t Get Greedy

Lots of penny stock investors see 200%, 500%, even 1,000% gains on a stock but still end up losing money in the end. It’s not because they didn’t plan their buys properly…it’s because they got greedy!

It doesn’t matter how much money a stock makes if you’re not ready to press the button and realize those gains. That’s why you need to set solid exit points for any penny stock you buy.

It’s human nature to want to hold onto an investment as you see it climb with no end in sight, but doing that is a great way to miss out if that trend turns around. When you analyze an investment, think about a logical exit price and sell for that. Picking solid exit points will become easier as you develop your investing chops.

3. Don’t Get Too Nervous

The flip side of getting greedy is getting nervous with stocks that are seeing major gains in short periods of time. Relax. As a penny stock investor, you’ve got to be ice-cold when you see one of your picks take off.

Again, it comes down to picking good exit points for your investments. If you’re sure that your stock is bound to start losing ground before you hit that target price, maybe it’s time to re-evaluate what that price should be.

Remember, you can reanalyze your targets anytime, but you should never make trades on emotion alone.

2. Be Realistic

While investors might hope for tripe-digit gains on every pick they make, even the most seasoned pros of the investing world make bad picks from time to time. That’s why having realistic expectations is so critical.

As with picking the right target prices, knowing what kind of gains to expect comes with experience as a penny investor. It’s tricky to know when you should expect 20% from a stock and when you should expect 200%.

But setting those realistic expectations now, from the get-go, will get you into a habit that will help you structure your portfolio in a way that will get you the most bang for your investment buck.

1. Be Ready for the Next One

It’s easy to sit back and relax after you’ve just made a trade — especially if you banked a nice gain. But not so fast!

As much as you might want to bask in your investing success, fight that urge.

The secret to the penny stock game is to always be on the move. Always be on the lookout for that next penny powerhouse — the next one might just be your best yet.

Cheers,

Jonas Elmerraji
June 27, 2008

P.S. That’s a lot to look for. This kind of steady research and analysis can be very tedious. In fact, by the time you finish it, you may have already missed the boat. These penny stocks can shoot up in the blink of an eye.

Penny Stock Investment Tips was originally featured in the Penny Sleuth.