So I finally made the dive into the stock market and purchased my first security – an S&P 500 ETF! In this post I hope to give the rational on why I decided to purchase this ETF and why I believe it would be a solid purchase for any young investor regardless of valuation.
Let me start with which specific ETF I chose. I picked the iShares Core S&P 500 ETF, ticker symbol IVV. When it comes to an S&P 500 ETFs, one really has three choices: SPY from SYDR, IVV from iShares, and VOO from Vanguard. Both VOO and IVV have an expense ratio of 0.04%, while SPY has an expense ratio of 0.09%. An expense ratio represents how much of your total investment you pay towards management and since all these ETFs do the same thing, the lower the expense ratio the better. The reason I picked IVV over VOO is simply because IVV has been around a bit longer than VOO. This may offer slightly more security in the sense that it is time tested, though there is very little difference between both these options and they are both great choices.
So, what exactly does this ETF do? Well, it simply tracks the performance of the S&P 500 index. This index is based on the market capitalization of 500 large companies listed on the NYSE or NASDAQ. The index is often believed to represent approximately 80% of the U.S. market, therefore making it a good representation of the market as a whole. The 0.04% expense ratio goes towards changing the holdings of the ETF once companies leave or enter the index. This relives the investor of worry that one of the companies might start failing and go bankrupt as it will be sold once its market capitalization lowers below a certain limit (6.1 Billion). It also allows the investor to not worry about “the next big thing” since by the time that “thing” is big enough to be a safe investment, it will enter the S&P and you will already own it.
The value investor may see the price to earnings ratio (P/E) for IVV of 23.94 and decide that it is overvalued or too expensive, and they may be right. They might look at the bull market we have been having for 10 years and think that a crash or correction is bound to happen soon, and they might be right. So, if markets aren’t looking that spectacular right now, why would I buy IVV? Well this is a long, long, long term investment for me. I might actually never sell it, and if I do, it won’t be for at least 30 years. The way I see it, the worst outcome is that I am purchasing this stock at the very peak of the market, meaning a crash will come literally next Monday. Now, if a crash happens, the longest time we have seen for the markets to recover in recent history is about 15-16 years. This happened when the market crashed in the tech bubble of the early 2000’s, then crashing again at a similar price in 2008, and then finally passing this level around 2014. This would mean the worst case scenario for me is that I need to wait 15 years for this stock to start making me some money, and since 15 years is only half of the minimum lifetime of this stock in my portfolio, it isn’t really a big deal.
Understandably one might ask: “Why wouldn’t you just wait to buy the ETF after the crash and get it for a discount?” There is a simple answer to this question and it is simply that I, nor anyone else, knows for certain that a crash will come, and if it doesn’t, it would be a shame to miss out on potential growth. This purchase takes up only around 10% of my portfolio, leaving plenty of cash (or cash equivalents) left over to snatch up more shares of IVV if the markets take a hit. I indeed plan to do this, as I also plan to purchase a similar amount of this ETF annually as a contribution to my TFSA. An annual contribution will likely dampen some of the volatility of this ETF over the long term while I can focus of the investing of other capital with a more active value based approach.
Long story short, I will be able to sleep at night knowing that one day, years from now, this money will be worth a significant amount more and I did not have to raise a finger.