What You Should Know About ETFs

Ryan: Does your portfolio need more ETFs? Not sure? Don't know what an ETF is even? No problem. Kiplinger.com investing editor Kyle Woodley has exchange-traded fund advice for beginners and old pros alike in our main segment. On today's show, Sandy gives us the rundown on tax software and she and I play a travel-themed edition of Deal or No Deal. That's all ahead on this episode of Your Money's Worth. Stick around.

• Episode Length: 00:28:49
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Ryan: Welcome to Your Money's Worth. I'm Kiplinger writer Ryan Ermey. Joined as always by senior editor Sandra Block. How are you doing Sandy?

Sandy: I'm good, Ryan.

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Ryan: It's still tax season. We're still-

Sandy: Every day.

Ryan: Every day until the 15th, we'll be here with you with more wise tax advice. Today, I wanted to talk a little bit about the mechanics of doing your taxes. For most people, it doesn't make sense to hire someone to do your taxes, or can you probably do them yourself?

Sandy: Unless your situation is pretty complicated. Maybe you own a business, you have rental income, tons of investment income, maybe then you want to pay somebody. But if your situation is pretty straightforward, there's really no reason not to use tax software. It's gotten so good, so intuitive, so fast. And depending on your situation, you can do your taxes for free or at a relatively modest cost. Certainly a lot less than you'd pay someone else to do your taxes.

Ryan: What is there available these days in terms of tech software that either gets paid for, that you might be able to get for free?

Sandy: The big disruptor, I hate that word, but it is a disruptor. I'm not going to say in this space, but in this space is Credit Karma Tax. Credit Karma Tax is 100% free. No matter how many forums you have to use, what you've got it's free. The reason that they get away with that or can do that is because they use this product to market you affiliate products; credit cards and things like that.

Sandy: As long as you go in knowing that that's the case, it's not really a bad thing. It's not a bad program, you don't get as much hand holding as you might with some products that you have to pay for. But the really good thing about this program is you're not going to get halfway through and then find out because you have a couple hundred dollars in investment income or drove an Uber for a week or something like that, that you suddenly have to pay. It is 100% free. That's for a federal and state tax return. The only real limitation is it can't do more than one state tax return. If you moved Credit Karma Tax probably isn't going to work for you.

Sandy: But in almost every other situation, I would say it's best for people who aren't totally new at this, because as I said, the support isn't as good as it is in some other programs we can talk about. But if you know your way around or your situation is just so simple, you've got a W2, you're not itemizing anything. There's really no reason not to try this program. If you get in and you decide you don't like it, you're not out any money.

Ryan: Yeah, you're just out a couple of... There are obviously a few that people are being inundated with commercials this time of year. Turbo Tax is obviously the really big one.

Sandy: Turbo Tax is the big one, and I think in a lot of ways it's the best. They will electronically import literally hundreds of types of documents. Usually your W2, a lot of the things you get from your financial institutions, and other programs do this too.

Ryan: It's a huge time saver.

Sandy: It's a huge time saver, and it reduces the amount of errors that you're going to make. Other programs do this, but Turbo Tax I think has the broadest reach there. Its got great support. The problem with Turbo Tax is I use it is if you've done it before, it's really hard to quit it, because they've got all your information on file, and they will just plug it in and just say, here you are, let's go.

Sandy: It's a great program. But they had an advertisement during the Superbowl. Well, who do you think's paying for that? You are. Turbo Tax is not cheap. They do have a free program. But it's very, very limited as to who can use it. Even if your situation isn't all that complex, it's really easy to get bumped up to deluxe or premium and you're getting it up into, for a state and federal tax return up to $100 or more to prepare and E-file your returns.

Sandy: Really, the knock on Turbo Tax is that it's not cheap. One thing that they had done more and more that they've gotten a lot of blowback for, and they're not the only ones to do this either is surge pricing. If you start your return now and find out shoot, I'm not going to file until April 15th, because I'm not getting any money. You may end up paying more than the price you saw when you started your return. This has become a growing and kind of disturbing trend in tax software. But Turbo Tax is I think one of the worst offenders.

Ryan: I've used H&R Block through free file for years. Obviously, H&R Block has an option for people who don't use free file as well.

Sandy: Yes, H&R Block is the... to Turbo Tax's hertz. A lot of people say it's almost as good if not every bit as good for a lot less money. If you're a newcomer to this, I would give it a look. It's not as expensive as Turbo Tax, it's definitely a lot more than Credit Karma Tax, and one of the problems here is that again, you can get bumped up pretty quickly.

Sandy: One of the things that's come up in the last few years is that just having a health savings account could disqualify you from some free or low cost programs. I think that's really unfortunate because having a health savings account is not a signifier that you have a complex return, it just means that you're saving money for health care, but it often will disqualify you and I think that's true with H&R Block's free program as well.

Sandy: But it's a good program, good support, it will electronically import a lot of your returns. I think they do engage in a little surge pricing, so pay attention to that. But it's definitely worth giving a look especially if you're new to this and you want to save some money.

Ryan: As is always our advice, shop around. We're going to put a link. We have a slide show coming out about, you said seven different-

Sandy: I'm not going to get into some of the other programs, but its gotten very competitive. There are a lot of other programs out there; TaxAct, TaxSlayer and they all have their pros and cons which we discuss on our slideshow on the website. My main takeaway for this is just read very carefully all of the terms, because what catches a lot of people up is they'll start plugging in all their numbers and then find out halfway through that they have to upgrade and there's a little bit of bait and switch there because if you've already put in all this information, they know you're not going to suddenly just throw up your hands and go to another program to save 20 bucks. You'll just cough up the 20 bucks and not be happy about it.

Sandy: So, read the disclaimers, read the fine print. But definitely, if your situation is not complicated, really consider doing your own taxes. It could take you as little as an hour and save you a lot of money.

Ryan: Once again, if you're someone who makes under $66,000 a year, take a look at Free File that's offered by the IRS. I've used it for years, and always just easy and effective. So, something to consider as well. Up next, Kyle Woodley tells you why you should consider an ETF and even recommends a few to buy now. Don't go anywhere.

Ryan: Welcome back. We are here with senior investing editor for kiplinger.com, Kyle Woodley. We talk a lot about mutual funds and stocks in this podcast. We always mention ETFs that we thought we would take a deeper dive today, and Kyle is the man for the job. Thank you for coming on, Kyle.

Kyle: Glad to be here.

Sandy: So, Kyle, I have most of my money invested in index mutual funds. Why would I want to move any of that to an ETF?

Kyle: Sure. Exchange-traded funds are great options for investors for many of the same reasons that mutual funds are. For one, they allow you to buy big baskets of stocks or bonds for a very low price, typically far less than the cost of eating the trading fees for hundreds or even thousands of stocks, not to mention the amount of time you spend just clicking buy, buy, buy in your brokerage account, and also how much you'd have to spend just a buy one share of that stock. Imagine having to buy 500 shares of stocks at those prices versus one ETF and that just costs say, $30, $50.

Kyle: You also have just one transaction fee there. Although you do pay an annual expense, that's a small percentage of what you have invested in the fund. One advantage that ETFs actually have over mutual funds is that they only charge those annual expenses. Mutual funds have annual expenses, but they also have sales charges. They can have marketing fees and other ways to nickel and dime you.

Kyle: ETFs also allow you to invest in other things that you'd have a difficult time accessing on your own. My favorite comparison is actually gold. You can invest in physical gold if you wanted to. But think about what goes into that. You have to find somewhere to buy the physical gold bars. You have to get them delivered, you have to have somewhere in your house to put the gold bars. You need a safe or a vault, you need to insure them. If you do ever want to unload them, you have to find a buyer and then you have to ship it off. None of that is easy or cost effective.

Kyle: If you're trying to just get a little bit of portfolio exposure to gold, why not buy a fund that charges you just a few bucks a year that goes up and down with the price of gold because your shares represent real gold that's sitting in real vaults. Lastly, one other major advantage is that while mutual funds basically trade just once a day, which is after the market closes, ETFs trade throughout the day, that exchange-traded funds, making them more suitable for quick trading, if that's your preference.

Ryan: We mentioned that these exchange traded funds trade like stocks, but does that introduce them to potential pitfalls because of the way that they trade?

Kyle: One of the big pitfalls with ETFs is actually their construction of what they have to do to mimic the indexes that a lot of them mirror. Many ETFs are index funds, so they need to buy and sell stocks that reflect changes in the index, and that means transaction costs. indexes don't have transaction costs. So, there's a difference in performance there.

Kyle: Sometimes it's not feasible to hold the thousands of stocks and bonds within an index, the transaction costs will pile up on stocks who's performance would have a negligible impact on the fund. The ETFs use a large sampling of the index holdings instead, there's another difference. Because of all these things, most ETFs don't perfectly replicate their indexes. The good news is, though, is that many of them have, it's just minute tracking differences. You're not losing a significant amount of performance.

Sandy: Why can't I buy an ETF for my 401(k) plan?

Kyle: It's not that you can't. ETFs are just so rare in 401(k)s that people think that they're not allowed but that's not the case. Really, the reasons why ETFs typically aren't offered in these plans is because many of their advantages, so the fact that they can trade in the middle of the day, their daily transparency, the fact that they're typically more tax efficient. They just go away in 401(k) because they're tax sheltered accounts that people typically don't day trade with.

Sandy: Is that the same for IRAs? Do people have ETFs in their IRAs? Is it a good idea?

Kyle: Oh, yeah, they do. I can tell you that I actually carry ETFs in my IRA, they're core holdings in my portfolio. I do stocks because I'm vain, and I think I know better than other people.

Sandy: Well, you write about it. That's okay.

Kyle: The core of my portfolio is actually several ETFs.

Ryan: Mine is, too. For someone like me, or someone who's starting out, doesn't have a ton of money to play with in their IRA necessarily. It's a way that you can give yourself access to a big broad swath of stocks or bonds, I guess if you're into that, without having to pay the oftentimes huge minimum at least for someone starting out. Like a $5,000 minimum for a mutual fund is a big deal.

Ryan: Whereas if I want to add some mid-cap, I can go out and buy the iShares midcap 400 ETF for what? A hundred bucks a share.

Kyle: That was exactly my mentality when I rolled over my first 401(k) into an IRA. I wanted a diversified portfolio, but I didn't have 10,000 to sink into an S&P 500 fun and then another 10,000 into a midpcap fund. But with ETFs, the nice thing is, is that all you need to be able to afford is one share. That can be anywhere between say 50. A lot of the S&P 500 funds are around 100, 120, but it's another great way to be able to get a diversified fund for very little in nominal dollar amounts.

Ryan: I think people generally think at least when they first started out that ETFs were just low cost ways to access indexes. But the world of ETFs has evolved pretty significantly here. Now people will, in addition to their traditional index ETFs probably see things branded as smart ETFs or smart data, and there's also some active ETFs. So, what should people be on the lookout for there?

Kyle: Sure. Index products were actually almost all of ETFs for so long that to this day, people still actually can flex it to. People think that when you say an index fund, you're actually talking about an ETF and vice versa. Real quick, an index fund, it just follows a very basic index. For instance, the S&P 500, which is just a list of 500 companies that trade on American exchanges, these are typically really simple and they weight their holdings by their market value. In other words, the bigger the company, the more effect it has on performance.

Kyle: Smart beta funds, they track indexes too, but they're designed differently. Smart beta funds might use indexes that determine what stocks to hold and how much weight to give them in the fund based on rules concerning metrics such as say, price to earnings ratios, cash flow, dividends, and all sorts of other metrics to meet very specific objectives.

Kyle: Active ETFs are just what they sound like. They're just exchange-traded funds with human managers making the investment decisions. People always like to ask the question, what kind is best? Is an index better than active? The very short answer is they're just good for different purposes. And so it's best to evaluate on the fund by fund basis.

Ryan: Right. Especially with the smart beta, it's, I think, worth noting that a lot of them advertise this back tested results for their methodology, because it's all automated portfolio construction there, right? But of course, as we always tell people, past performance isn't necessarily indicative of future results. So Kyle, before we let you go here, we wanted to get your take on a couple of ETFs. If someone's looking to dip their toes into that part of the market, what kind of ETFS would you recommend?

Kyle: Sure. ETFs can be used for anything from day trading where your time horizon is just a couple of weeks to literally years. You can build a buy and hold portfolio with ETFs. A couple of picks. I'll start out with first, the ones that we've targeted for 2019. One is the Legg Mason Low Volatility High Dividend ETF (LVHD).

Kyle: It looked appropriate for the high level of volatility that 2019 was setting up with after the fourth quarter of 2018 basically took us all to the woodshed. This fund searches for stocks with high sustainable dividend yields. Then it measures them based on their volatility in both their stock price and their earnings. In other words, it's looking for stocks that act calm when the market isn't.

Kyle: Typically, LVHD is going to perform a little worse in the market and bull runs, but a little better during periods of volatility and negativity. Another one that I like, I've actually liked it for years is ROBO Global Robotics And Automation Index ETF (ROBO), R-O-B-O.

Ryan: Great symbol.

Sandy: Sounds very Jetsony.

Kyle: It's their only ETF and it's based on, as the name would imply, robotics and automation which includes artificial intelligence. This is the way of the changing world right now, personal products, commercial offerings, industry, all of these are gravitating towards one or more of these technologies. The fund holds more than 90 stocks, split 50-50 between technology that's actually powering these changes and then the other 50% is in companies that are benefiting from these changes.

Ryan: Last thing we have to touch on, we obviously have our list of favorite ETFs: The Kiplinger ETF 20. Kyle, we have a few of this, let's talk about as well, right?

Kyle: Yeah. Four of these actually made my list as well because while they are good just buy and hold ETFs you can hold for years, they actually also work with the environment that we might be looking at here in 2019. You've got the Vanguard Total International Stock ETF (VXUS). If you wanted a national exposure, this is a set it and forget it fund. It covers more than 6,000 stocks. They're mostly in developed Europe and Pacific region, but they do have significant emerging market exposure to I think around 20%.

Kyle: There's the WisdomTree Global Ex U.S. Quality Dividend Growth Fund (DNL). Well, whenever you hear dividend in a fund, you're probably thinking like a higher than average yield. That's not the goal with the DNL. It's another global fund. What it does is it views dividend programs as a measure of quality. The yield is higher at the moment, but not by much. It's about 2.3% today versus the S&P 50O's 1.9%. We do have some bonds and these are actually active ETFs, there's SPDR's DoubleLine Total Return Tactical ETF (TOTL).

Kyle: Total is an actively managed fund whose goal is to beat the... benchmark. They try to find underpriced bonds and exploit that value. But they're happy to hold all sorts of kinds of debt. The portfolio can fluctuate from year to year. How it looks right now is probably not how it's going to look in a year, that's fine. Right now its biggest holdings are mortgage backed securities and treasuries. Right now it yields 3.5%.

Ryan: Which is very popular stuff at DoubleLine right now, who I guess you'd call it a sister mutual fund. We have at least one of them in the Kiplinger 25 funds, as well.

Kyle: Another one that we have is the PIMCO Enhanced Low Duration Active Exchange-Traded Fund (LDUR). LDUR is another actively managed bond fund. But this one focuses on short duration bonds. These have less sensitivity to interest rate movements. Typically, you have to accept low yields on short duration products. But because of the types of securities that this ETFs invest in, which includes mortgage backed securities and emerging market debt, you actually still get a nice yield of 3.2% right now.

Kyle: Also, I'd like our listeners to know. The Kip ETFs 20, this is updated every quarter. You want to check out the June issue to see if we've made any issues to that roster. For picks for 2019, if you just go online you'll just want to look up the 19 best ETFs for a prosperous 2019 on Kiplinger.com. That includes pics such sector, more bonds and even a couple of just broad market ETFs for your core.

Ryan: Well and there you have it. We will absolutely have links to both of those stories in this episode show notes. Kyle, thanks so much for coming on.

Kyle: Thanks for having me.

Ryan: Coming up, is it really worth it to skip the ID check at the airport? And why might you want to extend a layover? It's Deal or No Deal travel edition.

Ryan: All right. Before we go, we wanted to do a travel themed edition of Deal or No Deal. Sandy, I know that yours is about CLEAR, which I'm so curious about. It's something that I've seen in baggage lines. There's TSA PreCheck. And there's Global Entry, and there's this new one, CLEAR. Is CLEAR a deal?

Sandy: I think CLEAR is not a deal except for a very small number of very frequent business flyers. Here's how CLEAR works, it uses biometrics to store your fingerprints and your eyes scans and it creates an encrypted code that is specific to you. Basically, what that allows you to do is skip the line to have your driver's license and boarding pass checked. You scoot right by that, and then somebody escorts you to the pre check line.

Sandy: Here's the problem with this, it costs $179 a year. That's in addition to. It doesn't replace TSA PreCheck or Global Entry, it's in addition to TSA PreCheck and Global Entry. If you just did CLEAR, then you get past the first part, but then you'd have to go get back in the end of the line and take off your shoes and your belt. So nobody's going to do that. I think clear might have value to someone who's a really frequent flyer and needs to breeze through the airports to make their connections because they're on their way to New York for a big deal. But if you were just a basically leisure traveler, I think it's a pretty pricey benefit just to skip the part of the line where somebody stamps your boarding pass.

Ryan: Right, that's a short part of the line.

Sandy: Yeah, right.

Ryan: The long part of the line is take your shoes off, take your belt off, take your computer out, take your liquids out, which I never do.

Sandy: As I said, you have to have that anyway. PreCheck is $85 for five years, Global Entry is $100 for five years. I think if you've got those, I'm just not sure it's worth it to pay $179 a year just to skip that one step unless you're really busy, and maybe your company will reimburse you. Now, in our March issue, we have a story that does suggest a couple of ways to cut that cost. There are a couple of rewards cards that will rebate that. If you're really interested in it, check out our March issue and you'll see an article about comparing PreCheck and Global Entry and CLEAR. But the main thing I want to say about CLEAR is it is not a replacement for PreCheck or Global Entry. It's an addition to, and a pretty pricey one at that.

Ryan: I have a travel deal and one that I'm plan on hopefully utilizing sometime soon. That is a number of airlines are offering deals on stopovers. If you are flying a certain airline, I think the most famous one is Icelandair. If you're flying Icelandair into Europe and have a layover in Reykjavik, you can extend your stay in Reykjavik and you won't get charged more for a different flight if you use one of these stopover deals. In some cases, you may get discounted or even free hotel stays.

Sandy: If you wanted to check out the Northern Lights on your way to Europe, you could stay in Reykjavik a couple of extra nights and it wouldn't cost you anything more than the hotel and even that might be cut? That sounds like a great deal.

Ryan: Right? It wouldn't cost you any more than the flight. You don't have to pay any additional airfare. A few of these that I wanted to highlight quickly; Portugal's airline, TAP. Is it TAP? Is it T-A-P? I don't know. But they offer a deal up to five nights if you want to extend your layover in Porto or Lisbon, which I just came back from-

Sandy: And totally recommend.

Ryan: It's totally fantastic city. Air Canada through Toronto, Montreal and Vancouver. If your layover's over six hours, you can extend, and Turkish Airlines. Now, we have a little bit of a caveat here as our crack travel expert Miriam Cross points out to me that Turkey is currently a level three "reconsider" travel designation under the U.S. State Department. If that makes you queasy, then-

Sandy: Don't stop over there.

Ryan: Don't stop over there. Its been a few years since I've traveled to Turkey, but Istanbul was one of the most amazing cities I've ever been in. Through Turkish Airlines you can actually get free accommodations in Istanbul if you do one of these deals. There's a bunch of other ones too. So, it's worth, just to list Hawaiian Airlines, ThinAir, Singapore Airlines, Emirates, Qatar Airlines, Etihad.

Ryan: The bottom line is if you have travel coming up this year that's amorphous, there's a chance that you can be able to squeeze two trips for the price of one flight if you're willing to be flexible.

Sandy: I think the other appeal to that is if you're on a long trip, that gives you a break. I'm getting too old to stay on plane for 15, 20 hours. So, it's very appealing to me to be able to stop over in a city on the way somewhere, get some rest, walk around, see some sights and then get back on the plane. That's a really very appealing prospect.

Ryan: I think just the general advice is the best way to save on travel is to be flexible about when and where you travel and let the deals come to you. This is just another iteration of that. If you have travel plans for this spring or this summer that aren't necessarily set in stone yet, take a look at what airlines are offering because maybe they'll throw in an extra trip for you for free, basically.

Sandy: I'm ready to go to Iceland.

Ryan: Sold. That's it for this episode of Your Money's Worth. For show notes and more great Kiplinger content on the topics we discussed on today's show, visit kiplinger.com/links/podcasts. You can stay connected with us on Twitter and Facebook or by emailing us at podcast@kiplinger.com. If you like the show please remember to rate, review and subscribe to Your Money's Worth wherever you get your podcasts. Thanks for listening.

Links and resources mentioned in this episode

• Top Tax Software Programs for Your 2018 Tax Return
• The Kiplinger ETF 20 -- Our Favorite Exchange-Traded Funds for Every Investor
• The 19 Best ETFs to Buy for a Prosperous 2019
• Take Advantage of Airlines' "Stopover" Offers