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Small Cap Value (IWN) - Thesis

iShares Russell 2000 Value ETF (IWN)
Expected Return: 9.0% per year
Expected Volatility: 22.0% per year
Rating: BUY

Thesis:
As long-term investors, we believe the equity markets will increase over time, and the small cap value portion of the equity markets will increase more than other styles (e.g. large cap growth), albeit with more volatility.  The iShares Russell 2000 Value ETF (IWN) offers reliable exposure to the returns of the small cap value portion of the U.S. equity market while avoiding the many pitfalls that are common among other ETFs and among other equity investments in general.

Holdings:
IWN generally invests at least 90% of its assets in securities of the Russell 2000 Small Cap Value Index.  The fund may invest the remainder of its assets in certain derivatives such as futures, options, swap contracts and cash equivalents.  The index is one of the most commonly followed equity indices in the U.S., and is largely considered the standard benchmark for small cap value stocks.  The performance of IWN has historically matched the performance of the Russell 2000 Small Cap Value Index very closely, and it should continue to track closely in the future because of its construction methodology.  Investors cannot purchase the actual index (the Russell 2000 Small Cap Value Index), and IWN is the next best thing.

Volume and Liquidity:
As the standard small cap value ETF in the US, IWN has significant volume and liquidity (total IWN assets exceed $5.5 billion).  Because of the volume and liquidity, the bid-ask spread is small (the bid-ask spread is the difference in price at any given time for someone buying the security and someone selling it.  There is a difference because the middle man takes a very small cut).  A small bid-ask spread is good because it saves you money when you trade.  Second, IWN trades very close to its net asset value (NAV) because of the large volume and liquidity.  NAV is the actual value if you add up the value of all the securities held within IWN.  For many less liquid ETFs, the NAV may vary from its actual market price (the price the ETF trades at in the market).  This makes IWN much less risky for investors compared to other ETFs that may vary widely in price versus NAV.  Additionally, small investors don’t have to worry about some big investor coming in, buying or selling an enormous amount of IWN, and subsequently adversely moving the market price away from its NAV because the volume of IWN is already so great that this risk is essentially non-existent.  Additionally, the fund manager, iShares has the ability to take open-market actions to virtually eliminate the potential price impacts of large trades.

Low Fees:
The net expense ratio on IWN is currently 25 basis points (0.25%).  This is extremely low for small cap value market exposure; it is good for investors because it allows them to achieve better returns on their investment.  For comparison, small cap mutual funds (a common competitor to ETFs) may charge over 200 basis points (2.0%) per year, and they tend to deliver worse performance over the long-term.  Additionally, there is no expensive sales charge or separate investment advisor fee because IWN can be purchased directly through a discount broker (e.g. Scottrade, E*TRADE, TD Ameritrade, Interactive Brokers, etc.).  The discount broker may charge you a one-time trading fee of $8 or less, but this is much better than the 2-5% sales charge/management fee you’d get charged by a full service financial advisor.  Additionally, there is no hidden 25 basis point (0.025%) annual 12b-1 fee paid to someone for “servicing your account.”  The bottom line here is that IWN is a very low cost way to get great exposure to the equity market and to build considerable wealth over the long-term.

Dividend Reinvestment:
One last point of consideration, IWN pays a quarterly dividend (around 2.16% per year), and this dividend is NOT automatically reinvested back into IWN (this is standard protocol for ETFs and stocks).  This mean you’ll build up a cash balance in your account if you don’t withdraw it or manually reinvest it.  As a long-term investor, cash is generally a drag on investment performance.  Unless you plan to withdraw and use the cash, we highly recommend you develop a process to reinvest it.  Most discount brokers (Scottrade, Interactive Brokers, etc.) offer automatic dividend reinvestment programs.  We highly recommend you sign up for these programs to avoid the situation where cash builds up in your account and becomes a drag on your long-term investment performance.  Reinvesting dividends is important.

Conclusion:
IWN is a very low cost, relatively low risk, security that allows investors to build significant wealth over the long-term.  We consider IWN to be a basic building block for long-term wealth, and we rate IWN as a “Buy.”  For more information, you can view the IWN fact sheet here.

International Stock ETF (IXUS) - Thesis

iShares Core MSCI Total Int'l Stock ETF (IXUS)
Expected Return: 9% per year
Expected Volatility: 25.0% per year
Rating: BUY


Thesis:
As long-term investors, we believe the equity markets will increase over time, and the international (non U.S.) developed and developing (emerging) markets (countries with developed and developing economies) portion of the equity markets will increase at a slightly better rate than the U.S. market, albeit with higher volatility.  Non-US exposure also provides very important diversification benefits that are not available by investing in U.S. markets alone.  The iShares Core MSCI Total International Stock ETF (ticker: IXUS) offers reliable exposure to the returns of international markets while avoiding the many pitfalls that are common among other ETFs and among other equity investments in general.

Holdings:
IXUS invests in over 3,300 non-U.S. stocks from over 40 developed- and developing-market countries.  At least 90% of its assets are invested in securities of the underlying index (MSCI ACWI ex U.S. IMI).  The “IMI” portion of the index is important (it stands for Investable Market Index) because in addition to large cap and mid cap stocks, it also includes the small cap portion of the market (the version of the index without the “IMI” is only large cap and mid cap).  The fund may invest the remainder of its assets in certain depository receipts and derivatives such as futures, options, swap contracts and cash equivalents.  The index is one of the most commonly followed equity indices in the World, and is largely considered the standard benchmark for non-U.S. developed and developing market stocks.  The performance of IXUS has historically matched the performance of the MSCI ACWI ex U.S. IMI very closely, and it should continue to track closely in the future because of its construction methodology.  Investors cannot purchase the actual index, and IXUS is the next best thing.

Volume and Liquidity:
As a standard ETF, IXUS has significant volume and liquidity (total IXUS assets exceed $1.7 billion).  Because of the volume and liquidity, the bid-ask spread is small (the bid-ask spread is the difference in price at any given time for someone buying the security and someone selling it.  There is a difference because the middle man takes a very small cut).  A small bid-ask spread is good because it saves you money when you trade.  Second, IXUS trades very close to its net asset value (NAV) because of the large volume and liquidity.  NAV is the actual value if you add up the value of all the securities held within IXUS.  For many less liquid ETFs, the NAV may vary from its actual market price (the price the ETF trades at in the market).  This makes IXUS much less risky for investors compared to other ETFs that may vary widely in price versus NAV.  Additionally, small investors don’t have to worry about some big investor coming in, buying or selling an enormous amount of IXUS, and subsequently adversely moving the market price away from its NAV because the volume of IXUS is already so great that this risk is essentially non-existent.  Additionally, in the extremely rare case where a big trade could cause a big discount or premium, the fund manager (iShares by BlackRock) has the sophistication to engage in open market trading activity to avert the large mispricing relative to the NAV (some other ETF managers do not have this same level of sophistication).

Low Fees:
The net expense ratio on IXUS is currently 14 basis points (0.14%).  This is extremely low for international market exposure; it is good for investors because it allows them to achieve better returns on their investment.  For comparison, international mutual funds (a common competitor to ETFs) may charge over 300 basis points (3.0%) per year, and they tend to deliver worse performance over the long-term.  Additionally, there is no expensive sales charge or separate investment advisor fee because IXUS can be purchased directly through a discount broker (e.g. Scottrade, E*TRADE, TD Ameritrade, Interactive Brokers, etc.).  The discount broker may charge you a one-time trading fee of $8 or less, but this is much better than the 3-5% sales charge/management fee you’d get charged by a full service financial advisor.  Additionally, there is no hidden 25 basis point (0.025%) annual 12b-1 fee paid to someone for “servicing your account.”  The bottom line here is that IXUS is a very low cost way to get great exposure to the equity market and to build considerable wealth over the long-term.

Dividend Reinvestment:
One last point of consideration, IXUS pays a quarterly dividend (around 2.57% per year), and this dividend is NOT automatically reinvested back into IXUS (this is standard protocol for ETFs and stocks).  This means you’ll build up a cash balance in your account if you don’t withdraw it or manually reinvest it.  As a long-term investor, cash is generally a drag on investment performance.  Unless you plan to withdraw and use the cash, we highly recommend you develop a process to reinvest it.  Most discount brokers (Scottrade, Interactive Brokers, etc.) offer automatic dividend reinvestment programs.  We highly recommend you sign up for these programs to avoid the situation where cash builds up in your account and becomes a drag on your long-term investment performance.  Reinvesting dividends is important.

Conclusion:
IXUS is a very low cost, relatively low risk, security that allows investors to build significant wealth over the long-term.  We consider IXUS to be a basic building block for long-term wealth, and we rate IXUS as a “Buy.”  For more information, you can view the fact sheet for this ETF here.

U.S. Value Stock ETF (IWD) - Thesis

iShares Russell 1000 Value ETF (ticker: IWD)
Expected Return: 8.75% per year
Expected Volatility: 18.0% per year
Rating: BUY

Thesis:
As long-term investors, we believe the equity markets will increase over time, and the “value” portion of the equity markets will increase at a slightly better rate than the rest of the market.  Value stocks are defined as stocks with lower price-to-book ratios and less aggressive earnings growth expectations.  They’re basically stocks that are on sale.  Empirical research has shown that value stocks have outperformed the rest of the market over the long-term (10+ year periods).  Additionally, value stocks have moderately under-performed the rest of the markets over the last several years which makes them even more attractive (because they’re on sale).  We believe the reason value stocks have underperformed in recent years is because the accommodative monetary policies of the U.S. Federal Reserve since the great recession in 2009 have favored “growth” stocks.  Specifically, stocks that need to borrow more money to grow have been able to borrow it at attractively low rates because of the low interest rates set by the Fed.  As the Fed raises rates over the coming market cycle (they next three to 10 years) this will be a headwind to growth stocks and it will favor value stocks.  Regardless of where we’re at in the market cycle, value stocks tend to outperform over the long-term, and the Russell 1000 Value ETF (ticker: IWD) offers reliable exposure to the returns of value stocks while avoiding the many pitfalls that are common among other ETFs and among other equity investments in general.

Holdings:
IWD invests in over 650 large US companies classified as “value” stocks.  At least 90% of its assets are invested in securities of the Russell 1000 Value Index.  The fund may invest the remainder of its assets in certain derivatives such as futures, options, swap contracts and cash equivalents.  The index is one of the most commonly followed equity indices in the World, and is largely considered the standard benchmark for U.S. large company value stocks.  The performance of IWD has historically matched the performance of the Russell 1000 Value Index very closely, and it should continue to track closely in the future because of its construction methodology.  Investors cannot purchase the actual index, and IWD is the next best thing.

Volume and Liquidity:
As a standard ETF, IWD has significant volume and liquidity (total IWD assets exceed $23.5 billion).  Because of the volume and liquidity, the bid-ask spread is small (the bid-ask spread is the difference in price at any given time for someone buying the security and someone selling it.  There is a difference because the middle man takes a very small cut).  A small bid-ask spread is good because it saves you money when you trade.  Second, IWD trades very close to its net asset value (NAV) because of the large volume and liquidity.  NAV is the actual value if you add up the value of all the securities held within IWD.  For many less liquid ETFs, the NAV may vary from its actual market price (the price the ETF trades at in the market).  This makes IWD much less risky for investors compared to other ETFs that may vary widely in price versus NAV.  Additionally, small investors don’t have to worry about some big investor coming in, buying or selling an enormous amount of IWD, and subsequently adversely moving the market price away from its NAV because the volume of IWD is already so great that this risk is essentially non-existent.

Low Fees:
The net expense ratio on IWD is currently 20 basis points (0.20%).  This is extremely low for value stock exposure; it is good for investors because it allows them to achieve better returns on their investment.  For comparison, value mutual funds (a common competitor to ETFs) may charge over 150 basis points (1.5%) per year, and they tend to deliver worse performance over the long-term.  Additionally, there is no expensive sales charge or separate investment advisor fee because IWD can be purchased directly through a discount broker (e.g. Scottrade, E*TRADE, TD Ameritrade, Interactive Brokers, etc.).  The discount broker may charge you a one-time trading fee of $8 or less, but this is much better than the 2-5% sales charge/management fee you’d get charged by a full service financial advisor.  Additionally, there is no hidden 25 basis point (0.025%) annual 12b-1 fee paid to someone for “servicing your account.”  The bottom line here is that IWD is a very low cost way to get great exposure to the equity market and to build considerable wealth over the long-term.

Dividend Reinvestment:
One last point of consideration, IWD pays a quarterly dividend (around 2.49% per year), and this dividend is NOT automatically reinvested back into IWD (this is standard protocol for ETFs and stocks).  This means you’ll build up a cash balance in your account if you don’t withdraw it or manually reinvest it.  As a long-term investor, cash is generally a drag on investment performance.  Unless you plan to withdraw and use the cash, we highly recommend you develop a process to reinvest it.  Most discount brokers (Scottrade, Interactive Brokers, etc.) offer automatic dividend reinvestment programs.  We highly recommend you sign up for these programs to avoid the situation where cash builds up in your account and becomes a drag on your long-term investment performance.  Reinvesting dividends is important.

Conclusion:
IWD is a very low cost, relatively low risk, security that allows investors to build significant wealth over the long-term.  We consider IWD to be a basic building block for long-term wealth, and we rate IWD as a “Buy.”  For more information, you can view the fact sheet for this ETF here.

S&P 500 ETF (SPY) - Thesis

SPDR S&P 500 ETF (SPY)
Expected Return: 8.5% per year
Expected Volatility: 16.0% per year
Rating: BUY

Thesis:
As long-term investors, we believe the equity markets will increase over time, and the SPDR S&P 500 ETF (SPY) offers reliable exposure to equity market returns while avoiding the many pitfalls that are common among other ETFs and among other equity investments in general.

Holdings:
SPY generally holds all of the securities in the S&P 500 Index (it may omit a few during transitional periods, but not enough to significantly impact performance).  The index is one of the most commonly followed equity indices in the world, and many consider it one of the best representations of the U.S. stock market, and a bellwether for the U.S. economy.  Unlike other ETFs, SPY does not hold risky derivative instruments such as futures and swaps.  The performance of SPY has historically matched the performance of the S&P 500 index very closely, and it should continue to track closely in the future because it has essentially the same holdings as the index (investors cannot purchase the actual index, and SPY is the next best thing).

Volume and Liquidity:
SPY is the world’s largest ETF, and the world’s most highly traded ETF and equity security.  This scale has two significant benefits to investors.  First, because of the volume and liquidity, the bid-ask spread is small (the bid-ask spread is the difference in price at any given time for someone buying the security and someone selling it.  There is a difference because the middle man takes a very small cut).  A small bid-ask spread is good because it saves you money when you trade.  Second, SPY trades very close to its net asset value (NAV) because of the large volume and liquidity.  NAV is the actual value if you add up the value of all the securities held within SPY.  For many less liquid ETFs, the NAV may vary from its actual market price (the price the ETF trades at in the market).  This makes SPY much less risky for investors compared to other ETFs that may vary widely in price versus NAV.  Additionally, small investors don’t have to worry about some big investor coming in, buying or selling an enormous amount of SPY, and subsequently adversely moving the market price away from its NAV because the volume of SPY is already so great that this risk is essentially non-existent.

Low Fees:
The net expense ratio on SPY is currently less than 10 basis points (0.0945%).  This is extremely low for an ETF and extremely good for investors because it allows them to achieve better returns on their investment.  For comparison, mutual funds (a common competitor to ETFs) may charge 1-2% per year, and they tend to deliver worse performance over the long-term.  Additionally, there is no expensive sales charge or separate investment advisor fee because SPY can be purchased directly through a discount broker (e.g. Scottrade, E*TRADE, TD Ameritrade, Interactive Brokers, etc.).  The discount broker may charge you a one-time trading fee of $8 or less, but this is much better than the 2-5% sales charge/management fee you’d get charged by a full service financial advisor.  Additionally, there is no hidden 25 basis point (0.025%) annual 12b-1 fee paid to someone for “servicing your account.”  The bottom line here is that SPY is a very low cost way to get great exposure to the equity market and to build considerable wealth over the long-term.

Dividend Reinvestment:
One last point of consideration, SPY pays a quarterly dividend (around 2.0% per year), and this dividend is NOT automatically reinvested back into SPY (this is standard protocol for ETFs and stocks).  This mean you’ll build up a cash balance in your account if you don’t withdraw it or manually reinvest it.  As a long-term investor, cash is generally a drag on investment performance.  Unless you plan to withdraw and use the cash, we highly recommend you develop a process to reinvest it.  Most discount brokers (Scottrade, Interactive Brokers, etc.) offer automatic dividend reinvestment programs.  We highly recommend you sign up for these programs to avoid the situation where cash builds up in your account and becomes a drag on your long-term investment performance.  Reinvesting dividends is important.


Conclusion:
SPY is a very low cost, relatively low risk, security that allows investors to build significant wealth over the long-term.  We consider SPY to be a basic building block for long-term wealth, and we rate SPY as a “Buy.”  For more information, you can view the SPY fact sheet here.

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