Exchange-traded funds (ETFs) are growing at an astronomical rate. U.S. assets are closing in on $4 trillion. The ETF share of total assets at investment firms has expanded to nearly 16% from 8% at the start of the decade, while mutual funds have lost market share. The only problem with this explosive growth? The industry now boasts thousands of funds, making it difficult to determine the very best ETFs.
But investors are getting smarter about how they use ETFs in their portfolios. "After a decade of market gains, ETFs now play a unique role for investors as the foundation of a portfolio and also as vehicles that enable investors to be nimble," says Kari Droller, who oversees third-party mutual funds and ETFs at Charles Schwab.
We see a need to be nimble at present, so we're making some changes to our Kiplinger ETF 20 list of our favorite ETFs (with an eye toward small fees). Out are iShares Edge MSCI USA Momentum (MTUM), Vanguard Russell 2000 Value ETF (VTWV), Vanguard FTSE All-World ex-US Small Cap ETF (VSS) and Invesco Dynamic Large Cap Value (PWV).
So what's in? Some of the newcomers are meant to cushion your portfolio in a market downturn. One new entrant is simply a better strategy for investing in small-company stocks; another is a way to buy into some of the most innovative trends of our time.
Read on for our analysis of the 20 best ETFs that allow investors to tackle various strategies at a low cost - including the four newest additions to the list.
NEW ADDITION: Invesco S&P SmallCap Low Volatility
Market value: $2.0 billion
Yield: 2.7%
Expense ratio: 0.25%, or $25 per $10,000 invested
Trades commission-free at: Fidelity, Firstrade, Schwab, TD Ameritrade, Vanguard
Small-cap stocks tend to produce bumpy returns. Over the past decade, the Russell 2000 small-company stock index has been 37% more volatile than the S&P 500. Invesco S&P SmallCap Low Volatility (XSLV, $48.80) is designed to smooth out the ride. So far, so good: Since this ETF launched in early 2013, it has outpaced two small-company stock benchmarks - the Russell 2000 and the S&P SmallCap 600 - on an annualized basis, with less volatility.
There are cheaper options, but none as steady. Over the past five years, the ETF has outperformed its peers - other low-volatility and traditional small-company stock ETFs - with lower volatility in both up and down markets. We view this ETF as a core small-company stock holding.
The stock-picking process is simple. The ETF tracks a subset of the S&P SmallCap 600 Index that comprises 120 of the least volatile stocks, measured over the past 250 trading days. Stocks with the lowest volatility scores have a heftier rank in the portfolio regardless of market value. The ETF is nimbler than some of its peers because it recalculates the portfolio's constituents and rankings every three months, instead of twice a year.
But it's worth noting that exposures to certain sectors in the ETF can get lopsided; the fund doesn't employ any constraints to stay in line with its parent index, the S&P SmallCap 600. These days, the ETF has almost 70% of assets invested in financial services and real estate stocks combined, more than twice the exposure of the S&P SmallCap 600. The high concentration in dividend-rich sectors gives the fund a yield of 2.7%. Two real estate investment trusts (REITs) - Apollo Commercial Real Estate Finance (ARI) and Redwood Trust (RWT) - and commercial mortgage lender Granite Point Mortgage Trust (GPMT) are among the ETF's top holdings.
iShares Core S&P 500
Market value: $182.1 billion
Yield: 2.0%
Expense ratio: 0.04%, or $4 per $10,000 invested
Trades commission-free at: Fidelity, Firstrade, Vanguard
The S&P 500 is synonymous with the U.S. market and is the benchmark against which most large-cap managers are judged. Stocks such as Exxon Mobil (XOM), Apple (AAPL) and Bank of America (BAC) dot its holdings.
All three S&P 500-tracking funds easily rank as cheap ETFs. But the iShares Core S&P 500 (IVV, $299.23) has a key structural advantage. The classic S&P 500 index ETF - the SPDR S&P 500 ETF Trust (SPY) - is structured as a unit investment trust. As such, dividends from the SPY's underlying holdings must be held as cash until they are distributed to shareholders. As an ETF, IVV can immediately reinvest its dividends, improving its return.
iShares Core S&P Mid-Cap
Market value: $50.9 billion
Yield: 1.5%
Expense ratio: 0.07%
Trades commission-free at: Fidelity, Firstrade, Vanguard
iShares Core S&P Mid-Cap (IJH, $196.26) is the best pure play on mid-cap stocks, which offer almost all of the advantages of small caps but with much less risk, yet also boast more upside than many large-cap stocks.
According to data provided by the Schwartz Investment Counsel, a $1,000 investment made in the S&P MidCap 400 Index on March 1, 1984, would have been worth $78,398 at the end of 2019's second quarter. For comparison's sake, the same $1,000 investment made in large caps and small caps, respectively, would be worth only $43,577 and $32,660.
Standard & Poor's excludes financially weak mid-caps from this index - a culling that has enabled the S&P MidCap 400 to outperform other mid-cap indexes over the past 10 years.
Vanguard Total International Stock
Market value: $13.7 billion
Yield: 3.0%
Expense ratio: 0.09%
Trades commission-free at: Firstrade, Vanguard
Vanguard Total International Stock (VXUS, $51.70), which holds more than 7,000 stocks, is one of the cheapest ETFs to deliver stock exposure outside the U.S. Because it weights stocks by market value, the biggest companies dominate the fund; the median market value of its holdings is $27.5 billion.
Overall, the fund has about 78% of its assets in developed markets, led by Japan at 16.5%. Emerging markets such as China, India and South Korea round out the fund.
Vanguard Total Stock Market
Market value: $118.1 billion
Yield: 1.8%
Expense ratio: 0.03%
Trades commission-free at: E*Trade, Vanguard
Vanguard Total Stock Market (VTI, $152.21) gives you the entire U.S. stock market - large, midsize and small companies. The fund tracks the CRSP U.S. Total Market Index, which includes some 3,600 stocks, making it much broader than the S&P 500.
Still, large companies dominate the index; top holdings such as Microsoft (MSFT), Apple and Amazon.com (AMZN) mimic the S&P 500. As a result, the fund's return rarely deviates from the S&P by more than 1 percentage point or so in any calendar year.
Schwab US Dividend Equity
Market value: $9.8 billion
Yield: 2.9%
Expense ratio: 0.06%
Trades commission-free at: Firstrade, Schwab, Vanguard
Schwab US Dividend Equity (SCHD, $53.95) invests only in companies that have paid dividends every year for at least 10 years, that boast a market value of at least $500 million, and whose stocks have significant daily trading volume. Finally, only those companies with the best relative financial strength - as measured by four factors, including return on equity and five-year dividend growth rate - make the cut.
That leads to a portfolio of 110-plus stocks, led by the likes of Intel (INTC), Procter & Gamble (PG) and Home Depot (HD).
Vanguard Dividend Appreciation
Market value: $35.8 billion
Yield: 1.8%
Expense ratio: 0.06%
Trades commission-free at: Firstrade, Vanguard
Vanguard Dividend Appreciation (VIG, $117.73) is more concerned with whether a company has consistently boosted its annual dividend than about the size of the payout. Vanguard Dividend Appreciation tracks an index of large companies that have raised their annual payouts for at least the past 10 consecutive years. Limited partnerships, real estate investment trusts (REITs) and financially troubled companies are not eligible for inclusion.
The result is 184 mostly large U.S. stocks in a mix of industries, with the holdings weighted in the fund by market value. The fund rebalances once a month, as does the index it tracks. Its top three holdings are Microsoft, Visa (V), and Walmart (WMT).
The fund's focus on growth, says Morningstar analyst Adam McCullough, results in a higher-quality portfolio. "It reduces the fund's exposure to firms that may not be able to sustain their dividend payments, which is a risk that often accompanies a narrow focus on yield," he says.
WisdomTree Global ex-US Quality Dividend Growth
Market value: $75.7 million
Yield: 3.8%
Expense ratio: 0.58%
Trades commission-free at: E*Trade, Firstrade, Schwab, TD Ameritrade, Vanguard
WisdomTree Global ex-US Quality Dividend Growth's (DNL, $57.77) name suggests that it invests in international companies that increase their dividends - and ultimately, it does. But it takes a winding path to get there.
The fund invests in growing, high-quality dividend-paying firms in emerging and developed countries. The quality screen sorts companies by their historical return on equity and return on assets (both are measures of profitability). The growth screen zooms in on three- to five-year earnings growth expectations. "We created the same quality and growth screens that Warren Buffett likes," says Jeremy Schwartz, of WisdomTree.
Stocks in the fund are weighted by their share of the dividend stream of the index - the more they contribute, the bigger their share of the fund's assets. The rationale is that efficiently run firms with increasing earnings will likely raise dividends over time and have stocks that perform well, too. Top holdings right now include British American Tobacco (BTI) and Norwegian telecommunications company Telenor (TELNY).
NEW ADDITION: Ark Innovation
Market value: $1.7 billion
Yield: N/A
Expense ratio: 0.75%
Trades commission-free at: Firstrade, Vanguard
Ark Innovation (ARKK, $48.46) offers investors an efficient way to get in on some of the biggest groundbreaking advancements changing lives today. The actively managed ETF invests in stocks set to benefit from one of five future trends: DNA sequencing and the gene therapies that are born from it; robotics; energy storage (think electric cars); artificial intelligence; and blockchain technology (the algorithms behind digital currencies). Electric automaker Tesla Motors (TSLA) is the ETF's biggest holding, followed by 3-D printer firm Stratasys (SYSS) and Invitae (NVTA), a gene diagnostic and research company.
This is a shoot-the-moon investment, not a core holding. The ETF holds 37 stocks, which represent what ETF manager Catherine Wood of Ark Invest calls the money-management firm's "best ideas." Ark Invest also steers four additional active ETFs that target a single "disruptive innovation" theme, including Ark Web x.0 ETF (ARKW) and Ark Genomic Revolution (ARKG). Wood has a team of 20-odd analysts and traders working on those and on Ark Innovation ETF, which spans all of the themes. "We believe each stock in the portfolio will deliver a minimum 15% annualized return over the next five years," says Wood, though she concedes they may not be right about every single holding.
Over the past three years, Ark Innovation has returned an annualized 34.8%, which is roughly triple the S&P 500. But buckle up, because the ride has been extremely uneven. Over that period, the ETF was more than twice as volatile as the S&P 500.
Wood uses the turbulence to the fund's advantage. Consider Tesla, whose stock price bounces around a lot. In August 2018, shares hit $380. The stock dropped to $250 months later and then rocketed to $377 in early December 2018. In June 2019, shares were down to $223. "Innovation is controversial, so we lie in wait for controversy in order to build our positions," Wood says. "We buy shares at the lows and sell at the highs."
The trimming and padding of holdings adds to turnover, which at 89% is typical for a fund that focuses on tech stocks. But Wood is generally a buy-and-hold investor. Based on changes in holdings that shift in and out of the portfolio entirely, she says, the fund's turnover is closer to 15%.
Fidelity MSCI Industrials Index
Market value: $454.5 million
Yield: 1.7%
Expense ratio: 0.08%
Trades commission-free at: Fidelity, Firstrade, Vanguard
Fidelity MSCI Industrials Index (FIDU, $40.06) is among the best cheap ETFs for single-sector exposure. It tracks an index of roughly 340 industrial companies, in businesses ranging from construction equipment and factory machinery makers to aerospace and transportation.
The fund currently emphasizes giants such as Boeing (BA), Union Pacific (UNP) and Honeywell International (HON). These firms generate much of their sales overseas and would benefit from strong economic growth abroad and a weaker U.S. dollar, which also makes profits earned in foreign currencies worth more when converted to greenbacks.
About one-third of FIDU consists of small and midsize stocks. Smaller companies provide more exposure to sub-industries - such as electrical equipment, construction and engineering - and that adds to the fund's diversification. The fund's annual expense ratio of 0.08% is lower than that of any other industrials ETF.
Financial Select Sector SPDR
Market value: $25.2 billion
Yield: 1.9%
Expense ratio: 0.13%
Trades commission-free at: Firstrade, Vanguard
Financial Select Sector SPDR (XLF, $28.25) holds commercial banks such as JPMorgan Chase (JPM) and Wells Fargo (WFC) as well as insurers, financial-services firms and investment banks - a sector that's sensitive to changes that politicians in Washington might make to both regulations and interest rates.
But its top holding is Berkshire Hathaway (BRK.B), run by legendary investor Warren Buffett. Although Berkshire's big insurance unit gives it a lot of financial exposure, the company has stakes in everything from food products to railroads. No matter how the political winds blow in Washington, Berkshire should thrive.
Invesco S&P 500 Equal Weight Health Care
Market value: $734.9 million
Yield: 0.5%
Expense ratio: 0.40%
Trades commission-free at: E*Trade, Firstrade, Schwab, Vanguard
If you want the long-term growth of health care stocks but worry about a rough landing for high-flying biotech stocks, look no further. Invesco S&P 500 Equal Weight Health Care (RYH, $201.12) takes the 62 health care stocks in the S&P 500 and weights them equally. Thus, stocks such as PerkinElmer (PKI) and HCA Healthcare (HCA) have just as much say in the company's performance as companies such as Pfizer and CVS Health (CVS).
Pharmaceutical stocks represent 16% of the fund's assets, compared with more than 30% in the typical health care ETF.
NEW ADDITION: iShares Edge MSCI Min Vol USA
Market value: $30.6 billion
Yield: 1.8%
Expense ratio: 0.15%
Trades commission-free at: Fidelity, Firstrade, Schwab, Vanguard
iShares Edge MSCI Min Vol USA (USMV, $62.76) is an ETF that holds up well in rocky markets (Min Vol stands for minimum volatility). The fund tilts toward stocks of steadier large and midsize U.S. companies. "By reducing overall volatility, the fund delivers market-like returns with lower risk," says Holly Framsted, head of smart-beta ETFs for BlackRock's iShares. Over the past five years, iShares Edge MSCI Min Vol USA was 22% less jumpy than the S&P 500, and it beat the benchmark by an average of 2.4 percentage points per year with a 13.6% annualized return.
Low-volatility funds tend to lag the market in good times but lose less in tough times. In 2017, when the S&P 500 gained 21.8%, USMV trailed, but only by a bit, with an 18.9% return. But in late 2018, when the broad market index sank 19.4%, iShares Edge MSCI Min Vol USA lost only 12.6%.
The ETF rebalances twice a year to stay in line with its index. Recently, the fund's top holdings included Newmont Goldcorp (NEM), Waste Management (WM) and Visa.
NEW ADDITION: iShares MSCI USA ESG Select
Market value: $1.1 billion
Yield: 0.0%
Expense ratio: 0.25%
Trades commission-free at: Fidelity, Schwab, Vanguard
iShares MSCI USA ESG Select (SUSA, $124.10), which focuses on environmental, social and corporate governance characteristics to pick stocks. If you think ESG investing involves some tree-hugging, you're right. But it is more than that. The best firms based on ESG criteria are mindful of their environmental impact but also treat employees, customers and their community well and have a diverse pool of ethical managers who are aligned with shareholder interests. All of these characteristics (and more) add up to well-run firms that perform better over time, the thinking goes.
In other words, ESG tenets make good business sense and thus good investment sense.
ESG ratings can help identify a firm's problems before they come to light and snarl the stock. MSCI, a data provider that rates firms on ESG factors, flagged data and privacy issues at Equifax (EFX) and downgraded the company's ESG score to the lowest possible rating a full year before hackers breached the credit-reporting agency's database. (MSCI's ESG ratings resemble bond credit ratings and range from the best, triple-A, to the worst, triple-C.) Analyzing companies through an ESG lens can "catch problems in advance," says Todd Rosenbluth, a CFRA mutual fund and ETF analyst.
Investors are clamoring for ESG-focused funds. Assets in this category more than doubled in 2018, Rosenbluth says. That's more than the 24% asset growth overall in smart-beta ETFs. Not surprisingly, dozens of promising, socially conscious ETFs have launched over the past two years. But we're wary of recommending funds with such short track records. However, iShares MSCI USA ESG Select has been around since 2005 and boasts one of the longest track records in socially responsible investing.
What's more, its index tracks the best of the MSCI ESG-rated companies. After eliminating companies that make tobacco products, weapons, alcohol or nuclear power, or are involved with gambling, the index targets firms with the highest MSCI ESG ratings. According to BlackRock, 73% of the holdings in the index and the ETF have a triple-A or double-A MSCI ESG rating - the two highest ratings. The 100 stocks in the ETF are ranked by their ESG rating (the better the rating, the bigger the firm's representation in the fund), and the portfolio is rebalanced four times a year. Microsoft, Ecolab (ECL) and Apple are top holdings. Over the past five years, iShares MSCI USA ESG Select has returned 10.7% annualized, shy of the S&P 500's annual average gain of 11.2%.
Pimco Active Bond
Market value: $2.5 billion
Yield: 3.1%
Expense ratio: 0.55%
Trades commission-free at: E*Trade, Firstrade, Schwab, Vanguard
PIMCO Active Bond (BOND, $107.74) is, as its name suggests, an actively managed ETF (most ETFs merely seek to match an index). The ETF is run like Pimco's flagship mutual fund, Pimco Total Return (PTTAX). It's on this list of the best cheap ETFs because of its relatively low expenses - relative to other active bond offerings.
The fund holds $2.5 billion in assets; the mutual fund, which was once the biggest in the land, contains $66 billion.
Pimco has seen a good bit of turmoil in past years with the resignation of co-founder Bill Gross (who just retired from Janus Henderson), but we think the firm still has a lot of talent.
SPDR DoubleLine Total Return Tactical
Market value: $3.4 billion
Yield: 3.1%
Expense ratio: 0.55%
Trades commission-free at: Vanguard
We're fans of Jeffrey Gundlach, a comanager of this actively managed ETF with Philip Barach and Jeffrey Sherman. He and Barach also run DoubleLine Total Return Bond (DLTNX), which is a member of the Kiplinger 25, the list of our favorite no-load mutual funds - although the fund and the ETF are not clones.
SPDR DoubleLine Total Return Tactical (TOTL, $48.84) draws on the view of Gundlach and his asset allocation team on the global economy and world markets. The ETF currently invests mostly in bonds with credit ratings of BBB or better (almost 70% are top-rated AAA) that it deems attractively priced.
But almost anything goes. The fund can invest in corporate debt, government bonds, floating-rate securities, foreign corporate and government IOUs, and Gundlach's bailiwick - mortgage-backed and asset-backed securities. There are some guard rails. No more than 25% of the ETF's net assets can be invested in high-yield debt, and no more than 15% in foreign-currency-denominated securities. But there is no cap on mortgage-backed securities. At last report, the fund had 44.5% of its assets invested in MBSes and 19.6% in Treasuries.
DoubleLine Total Return Tactical yields 3.1% and its duration is 3.6 years, implying that if rates were to fall by 1 percentage point, the fund's net asset value would drop 3.6%.
Invesco Senior Loan Portfolio
Market value: $5.1 billion
Yield: 5.8%
Expense ratio: 0.65%
Trades commission-free at: Schwab, Vanguard
Invesco Senior Loan Portfolio (BKLN, $22.82) holds loans made by banks to heavily indebted firms with poor credit ratings. These junk-rated borrowers are charged "floating" interest rates that are typically tied to a short-term benchmark: the London Interbank Offered Rate, or LIBOR. When LIBOR rises above a certain level, rates on these loans bump up, helping them hold their value better than bonds.
The portfolio at the moment includes more than 115 holdings, with more than half of that invested in debt that has earned a low B rating.
iShares Ultra Short-Term Bond ETF
Market value: $1.7 billion
Yield: 2.6%
Expense ratio: 0.08%
Trades commission-free at: Fidelity, Vanguard
iShares Ultra Short-Term Bond (ICSH, $50.37) is an actively managed fund that offers a mix of high-quality bonds with one- to three-year maturities.
Roughly 75% of the portfolio - a mix of short-term corporate notes, investment-grade floating-rate bonds and some certificates of deposit - is rated single-A or better. (Investment-grade ratings start at triple-B and go up to triple-A.) What's more, the fund has a low 0.4-year duration. That means if rates were to rise by one percentage point, the fund's net asset value would fall a mere 0.4%.
Pimco Enhanced Low Duration Active
Market value: $359.3 million
Yield: 3.2%
Expense ratio: 0.39%
Trades commission-free at: E*Trade, Firstrade, Vanguard
We added Pimco Enhanced Low Duration Active (LDUR, $100.31) to the Kip ETF 20 roster as a defense against rising rates. The managers behind the fund - Hozef Arif, David Braun and Jerome Schneider - are Pimco veterans. Their goal is to keep the portfolio's sensitivity to interest-rate moves low.
The ETF currently has a 1.6-year duration. That implies that if interest rates overall were to rise by 1 percentage point, the fund's net asset value would drop by roughly 1.6%. Compare that with the five-year-plus duration of the broad bond market bogey, the aforementioned Agg index.
The fund's yield is boosted in part by investment-grade corporate debt, mortgage-backed securities and a smattering of exposure to emerging-markets and high-yield corporate debt.
Vanguard Total International Bond
Market value: $13.7 billion
Yield: 0.5%
Expense ratio: 0.09%
Trades commission-free at: E*Trade, Firstrade, Vanguard
Vanguard Total International Bond (BNDX, $57.96) tracks an index of foreign bonds. But despite its name, this cheap bond ETF doesn't invest in every international debt security. Rather, the fund focuses on high-quality, investment-grade bonds. The portfolio is filled primarily with government and quasi-government debt issued mostly in developed countries (though 4.3% of the portfolio's assets are in emerging-markets debt, at last report).
Because the fund holds bonds issued in local currencies, not U.S. dollars, Total International Bond hedges against currency risk, which sets it apart from many world bond funds. Hedging "smooths the ride," says Wyatt Lee, of T. Rowe Price Group, who notes that "Currency (fluctuations) can double the volatility of a global bond fund."
The caveat is the fund's duration of just more than eight years, implying an 8% decline in net asset value for every one-point rise in rates. Although interest rates abroad are currently low and expected to stay that way for the time being - especially in Japan and Europe, where much of the fund's assets are invested - when interest rates eventually rise, it could crimp returns.
We'll be keeping an eye on that.