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How To Easily Build, Manage and Run

a Successful Stocks & Shares ISA

What ETFs to invest in
Different Sized SIPP Accounts Mean Different ETFs
Not every reader's ISA will have the same monetary value.

Some might be worth in excess of £25,000, others less than £5,000. But as I indicated at the beginning of this guide unless you have an ISA worth at least £4,000 alongside a firm commitment to continue to fund it year after year, it is better to hold stocks outside an ISA as it offers more flexibility.

Investors should therefore consider 2 types of ETFs to invest in -

  • Group 1: The foundation ETFs. All issued by iShares and are the most important ETFs covering all the main asset classes

  • Group 2: More defined ETFs. To be used if your portfolio's value is above £10,000 they offer a wider range of markets to invest in. For example, it's easy to invest in an ETF which covers the umbrella of Emerging markets (which is one of the foundation ETFs), this invests directly into 25 country stockmarkets such as Peru, Taiwan and South Africa. But using a more defined ETF it's possible to invest directly into say the Taiwanese stockmarket
The Foundation ETFs

Equity ETFs - UK Stockmarket

Note, the ticker (referred to as the EPIC) symbols for the different ETFs are in brackets.

The following are the ETFs that should be used to invest in the UK stockmarket. Prices for these and all the different ETFs mentioned can be found on all the main financial websites. Personally I like Google Finance.

Comments:

Buying both the FTSE 100 and FTSE 250 ETF in equal measure will create a position that mimics the FTSE 350, comprising the largest 350 companies on the London Stock Exchange. Although the FTSE 350 will not track the FTSE All Share Index exactly because that's made up of around 800 stocks, it will come close.

Equity ETFs - European & North American Stockmarkets
  • MSCI Europe Ex-UK (IEUX) - This ETF offers exposure to over 400 non-UK stocks across the European Union, Scandinavia and Switzerland. 'Ex-UK' obviously means no UK stocks are involved - chart - iShares information

  • MSCI North American - INAA - Offers exposure to 665 US and Canadian companies. This ETF matches approximately 85% of the combined market capitalization of the US and Canadian markets and is composed mainly of US shares with only 6% of the index made up of Canadian stocks - chart - iShares information

Comments:

MSCI stands for Morgan Stanley Capital International who run and publish a collection of very well respected and widely followed global stockmarket and financial indexes. Most global ETFs are structured to represent these indexes, more information can be found on their website www.mscibarra.com

Both the continental European and North American ETFs offer quick and simple access to these stockmarkets and because they invest in many stocks they offer a good balance, ie they don't just invest in the largest brand name companies.

Comments:

The Japanese stockmarket is important for long term investors because in my view it's not as highly correlated to the Western markets. Japan is also the world's second largest economy, roughly half the size of the US but nearly 4 times the size of the UK. For these reasons it can be unwise for long term investors to ignore it.

Equity ETFs - Emerging Markets
The definition of an emerging market is a country whose economy is small but growing. One of the main characteristics of an emerging market is that on the one hand it offers higher growth potential than more developed nations such as the UK or US, but conversely these markets are normally more volatile.

Comments:

The MSCI Emerging markets ETF consists of stocks from countries such as Argentina, Brazil, Chile, Malaysia, Pakistan, South Africa and Turkey.

Fixed Income ETFs
Another name for a bond is a fixed income security. In its simplest form a bond is a piece of paper that pays the owner an annual income (yield), plus at maturity (when the bond expires) it will repay the original capital invested.

For example, the UK Government always needs to borrow money so it issues Bonds which in fact are known as Gilts because the edge of the certificates of ownership used to be edged in gold leaf, hence Gilt-Edged Securities.

So a 2015 5% £100,000 Gilt will -

  • Repay the holder £100,000 when it matures in the year 2015
  • Pay an annual yield of 5% or £5,000 until maturity in 2015

It is important to realise that a bond is not like a deposit account at a bank. Yes, they both pay interest but the price of a Bond can move up or down. Basically the price of any bond will reflect current interest rates plus expected economic prospects. As a strong rule of thumb, if interest rates rise bond prices fall, and vice-versa.

Bonds are a very important asset to own because they are lower risk than equities and they produce an income. Yes, bonds can fall as well as rise in value but because we will only be investing in ETFs which in turn solely buy government or the corporate bonds of blue chip companies there is little risk of any bond becoming worthless.

Corporate bonds work in the same way as Government bonds but have slightly more risk attached because any company can theoretically go broke far more easily than a country. This is because countries control the money printing presses so in extreme cases they can always print extra money to repay their debts. This means that Corporate bonds have more inherent risk than Government bonds so they will normally always pay a higher yield, although this is not cast in stone.

But as long term investors in Bonds/Gilts we don't have to overly concern ourselves with the economics behind how they're priced, or the inherent risks of one over the other, just the fact that fixed income securities are an important asset class for any long term investment portfolio.

  • FTSE UK All Stocks Gilt (IGLT) - offers exposure to a diversified basket of UK government Gilts/bonds across all maturities (a few months to 15+ years). All bonds are AAA rated - chart - iShares information
Comments:

All Bonds come with a rating , AAA, AA, A, BBB, BB etc.

The higher the rating the safer the bond, but conversely the smaller yield it will pay. So a AAA rated bond might pay 2% while a BBB pays 8%. A perfect example of the risk reward ratio - accept more risk with the potential of far higher rewards or accept low risk with far lower potential for reward.

Property ETFs

Firstly, I am not suggesting that readers should invest in physical property, but rather invest in ETFs which in turn invest in other property funds, including a new style of property funds called REITs.

The reason for adding property to a portfolio is threefold -

  1. Property carries lowish risk over the long term with prices generally appreciating
  2. Rents are paid on property hence a yield on the ETF
  3. Property often has a lowish correlation to the stockmarket
Comments:

The property company shares and REITs (Real Estate Investment Trusts) which this ETF invests in hold a mixture of retail, office and industrial properties. Because REITS have to pay a large percentage of their profits as income this ETF should pay a good dividend.

REITS are tax efficient investment trusts that can only invest in property. They are quoted on the stockmarket, trade like a share and do not pay Capital Gains Tax on rental income received.

Group 2 ETFs - Getting more flexible
There are about 100 different iShare ETFs being quoted on the London stock Exchange across the 3 main asset classes: equities, bonds and property.

So how you choose to get more flexible is up to you. For example, one ISA investor might want to get heavily involved in the Emerging market ETFs such as Brazil and South Africa. Another might prefer to invest in more detail in the fixed income sector so might utilise a selection of the 5 UK fixed income ETFs including corporate bonds.

In the second of the 2 sample portfolios below I show how I would use some of the more specific ETFs in place of the foundation ones.

Summary

I have explained what ETFs are and their advantages over traditional investment funds. I have also listed some of the more common ETFs (the foundation ETFs) and the ones that I personally use to invest in.

However, you don't have to pick the same ones as me as you may want to get more creative and use ETFs to zero in on certain markets. This is the beautiful thing about using ETFs to build an investment portfolio, they simple, flexible and varied.

Now, it's time to use the ETFs to build a portfolio, and one that's built to last.


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