By Tezcan Gecgil, PhD
What a year 2020 has been for investors! As we get ready to enter the last quarter of the year, volatility with a downward bias is back in many equity markets, not just in the US but also worldwide. Therefore today, we”ll discuss how investors may consider taking advantage of lower prices and start building a long-term portfolio with exchange-traded funds (ETFs).
A “New-Normal” For Investors
What has started as a “normal year,” was followed by news of a novel coronavirus from China. While the pandemic started affecting billions of citizens worldwide, stock markets were not forgiving. By mid-March, most of the darlings of Wall Street at 52-week lows.
Yet, unprecedented stimulus by the Fed, as well as other central banks, hopes of a vaccine against Covid-19, lower prices in equities and funds, as well as improving investor sentiment meant stocks returned to their January highs. In fact, many companies have since made all-time highs.
Despite the spectacular comeback in equity markets, a wide range of market participants have been quite sceptical of the rapid and somewhat exponential increase in shares prices. After all, could backstops by the Fed be enough? The debate whether significant economic fundamentals affecting the “Main Street’ is continuing. Millions of people have lost their jobs in the US, meaning consumers may easily decrease their spending levels. Both domestic and international travel is still at depressed levels, not seen in decades.
October means the start of a new earnings season. Excluding a number of “stay-at-home, work-from-home” shares, many companies reported significant revenue and earnings declines in the previous quarter. The upcoming metrics may not necessarily be any better. Analysts do not concur on the pandemic’s cumulative hit to growth.
Finally, the US Presidential election in November will mean more choppiness for stocks. In the case of a delay in announcing the results, we can all expect the equity markets to shed a sizable amount of market capitalization (cap).
So far, the moves in September may be proving right those who doubted the run-up in stock since early spring. We are now seeing erratic action with a downward bias in most stocks. However, for long-term investors such short-term noise in the markets should not be concerning. When you have decades to invest, weekly or even monthly moves should not matter much for your long-run portfolio aims.
With that said, let’s take a look at an ETF that may be appropriate for most retail investors who would like to take advantage of falling prices asn the “new-normal’ way of life for billions of global citizens.
According to research by Ross Loehr and Reinhold Lamb of University of North Florida,
“ETFs afford the investor the ability to trade these investments like an individual stock, while often offering the diversification of a mutual fund. Mutual funds are sold once per day at the closing Net Asset Value of the fund, while ETFs are liquid and can be traded throughout the day, making them much more liquid than traditional funds.”
Vanguard Total Stock Market ETF (NYSE:VTI)
- Current Price: $169.09
- 52-Week Range: $109.49 – $181.67
- Dividend Yield: 1.71%
- Year-to-date % Change in Price: Up 3.34%
- Expense Ratio: 0.03% or $0.3 on an investment of $1,000
Those investors looking for a low-cost fund may find the the Vanguard Total Stock Market ETF (NYSE:VTI) appealing. With its 3525 holdings, the fund provides diversification across arge-, mid-, and small-cap businesses. Assets under management are close to $1 trillion.
VTI follows the CRSP US Total Market Index. The top sectors in the fund are Technology (27.8), Financials (15.5%), Consumer Services (14.7%), Health Care (13.4%), and Industrials (11.70).
The top ten stocks make up over 25% of the fund. VTI’s top five holdings include Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), and Facebook (NASDAQ:FB).
Over the past 12 months, the fund is up over 10%. Yet in September, it is down around 5%. We find the valuation levels on the expensive side. For example, trailing P/E ratio is 27.5 and P/B ratio is 3.5.
Therefore, VTI may come under further pressure in the coming weeks, especially if profit-taking continues to hit the tech heavyweights. Long-term investors may regard any drop, especially toward the $150-level as good opportunity to buy the shares.
Those investors who already own VTI but are concerned about the prospects of falling prices may also consider initiating an at-the-money (ATM) or slightly in-the-money (ITM) covered call position, for example, with a two-month time horizon, i.e., November 20 expiry. Such a covered call position would offer some downside protection. You would also be able to participate in a potential up move.
