An Introduction to Bullish ETFs for Stock Investment - dummies

An Introduction to Bullish ETFs for Stock Investment

By Paul Mladjenovic

You may wake up one day and say “I think that the stock market will do very well going forward from today” and that’s just fine if you think so. Maybe your research on the general economy, financial outlook, and political considerations make you feel happier than a starving man on a cruise ship.

But you just don’t know (or don’t care to research) which stocks would best benefit from the good market moves yet to come. ETFs can be a good investment option for you.

Major market index ETFs

Why not invest in ETFs that mirror a general major market index such as the S&P 500? ETFs such as SPY construct their portfolios to track the composition of the S&P 500 as closely as possible. As they say, why try to beat the market when you can match it? It’s a great way to go when the market is having a good rally.

When the S&P 500 was battered in late 2008/early 2009, the ETF for the S&P 500, of course, mirrored that performance and hit the bottom in March 2009. But from that moment on and into late 2012, the S&P 500 (and the ETFs that tracked it) did extraordinarily well. It paid to buck the bearish sentiment of early 2009.

Of course it did take some contrarian gumption to do so, but at least you had the benefit of the full S&P 500 stock portfolio, which at least had more diversification than a single stock or a single subsection of the market.

ETFs related to human need

Some ETFs cover industries such as food and beverage, water, energy, and other things that people will keep buying no matter how good or bad the economy is. Without needing a crystal ball or having an iron-will contrarian attitude, a stock investor can simply put money into stocks — or in this case, ETFs — tied to human need. Such ETFs may even do better than ETFs tied to major market indexes.

At the end of 2007, an ETF in consumer staples (in this case, “PBJ”) beat out the S&P ETF by about 20 percent (not including dividends).

ETFs that include dividend-paying stocks

ETFs don’t necessarily have to be tied to a specific industry or sector; they can be tied to a specific type or subcategory of stock. All things being equal, what basic categories of stocks do you think would better weather bad times: stocks with no dividends or stocks that pay dividends? (The question answers itself, pretty much like “What tastes better: apple pie or barbed wire?”)

Although some sectors are known for being good dividend payers, such as utilities (and there are some good ETFs that cover this industry), some ETFs cover stocks that meet a specific criteria.

You can find ETFs that include high-dividend income stocks (typically 4 percent or higher) as well as ETFs that include stocks of companies that don’t necessarily pay high dividends, but do have a long track record of dividend increases that meet or exceed the rate of inflation.

Given these types of dividend-paying ETFs, it becomes clear which is good for what type of stock investor:

  • For a stock investor who is currently retired, the high-dividend stock ETF would be the better option. Dividend-paying stock ETFs are generally more stable than those stock ETFs that don’t pay dividends, and dividends are important for retirement income.

  • For the “pre-retirement” investor (some years away from retirement but clearly planning for it), the ETF with the stocks that had a strong record of growing the dividend payout are the better option. That way, those same dividend-paying stocks would grow in the short-term and provide better income down the road during retirement.

Keep in mind that dividend-paying stocks generally fall within the criteria of “human need” investing because those companies tend to be large and stable, with good cash flows, giving them the ongoing wherewithal to pay good dividends.

To find out more about ETFs in general and to get more details on some the ETFs (SPY, PBJ, and SH), go to websites such as ETF Database and ETF Guide.