Join the conversation and feel free to submit a question to our experts.

Submit a question


Listen in on our hour-long show, from Monday-Friday 12-1pm on KPRC AM 950


Stay up to date and have the STA Weekly Report and 401k Plan Manager emailed to you.



Read STA's Featured Articles

Read More

STA Weekly Report – Is Your Advisor Using the Right Metrics to Select ETFs?

Print Friendly, PDF & Email

Is Your Advisor Using the Right Metrics to Select ETF’s?
Weekly Technical Comment|
Weekly Snapshot of Global Asset Class Performance
401k Plan Manager

The ETF universe has grown in terms of both offerings and assets over the last 10 years as investors have looked to replace expensive actively managed mutual funds with inexpensive index ETF’s.

Read More

Source: STA Wealth Management

As a result of the growth in the number of products available, it has become more difficult than ever to select the best ETFs for use within portfolios. Think about the challenge investors face in having to sort through numerous products with similar names, similar benchmarks, differing replication methods, weighting methodologies, and performance track records. Without a proper ETF selection approach, investors are often left with suboptimal ETF selections that increase portfolio risk and can dampen potential returns. Adding to the challenge is that the media and largest fund sponsors have espoused cost as the most important consideration when selecting an investment vehicle. As costs converge toward zero in many instances, the water is muddied further.

At this point, we do believe it is important to point out that while we agree that cost is an important consideration, we do believe a more nuanced and sophisticated view of cost is required to select ETFs for a portfolio. You see, to get an accurate view of cost, multiple cost components, both implicit and explicit, must be aggregated together. Unfortunately, many investors rely strictly on the published expense ratio, which can on its own be misleading.

What does a more comprehensive calculation of true ETF cost look like? We believe the total cost of ownership is best measured by combining total cost to hold the investment over time and total cost to trade the investment. In our view, each of these is comprised of two different costs each. For total cost to hold, we add together the published expense ratio and a measure that rarely gets much coverage called the tracking difference. To obtain a total cost to trade, we favor adding together the explicit transaction costs of entering and exiting an ETF investment and an implicit cost associated with the fund’s prevailing bid/ask spread. 

Source: STA Wealth Management

Let’s break each of these components down a bit.

Expense ratio is the fund’s total annual operating expense expressed as a percentage and is typically readily available on an ETF factsheet or the fund’s most recent prospectus. For a widely held investment like the SPDR S&P 500 ETF (SPY), the expense ratio is 0.0945% as of August 30, 2019.

Tracking difference is a measure of how an ETF’s performance compares to the performance of the underlying benchmark index over a period and is calculated by subtracting the benchmarks total return from the fund’s net asset value. Tracking difference is much more applicable when an investor looks to measure performance on a total return basis. This differs from the more widely discussed tracking error in that tracking error is a measure of performance consistency. Instead of measuring performance, it measures an annualized standard deviation for a selected time period and can help answer how consistent the tracking difference is between an ETF and its benchmark.

Bid/Ask spreads are the difference between the bid price or the price which a buyer is willing to pay to purchase shares of the ETF and the asking price, which is simply the price a seller is willing to take to part with his or her ETF shares. The spread, or difference, between the two is the cost of executing a transaction of an ETF in the secondary market. For investors not familiar with the mechanics of trading an ETF it may be helpful to think of it like a business where you have input costs plus a profit margin. For an ETF, input costs include a creation/redemption fee, a spread of the underlying securities contained in the ETF, and risk. While it is not necessary to know the exact details of what these consist of, what is important to know is that if any of these three costs rise, the spread increases and make it more expensive for an investor to purchase or sell the ETF. You can think of it like a retailer that raises prices in response to a price increase from a wholesaler.

Transaction costs, just like the expense ratio is another explicit cost. To buy or sell an ETF, investors typically pay a trading fee. At most custodians, this fee is typically well under $10 to buy and $10 to sell. To convert the fee into a percentage, simply take the total transaction costs (buying + selling) and divide it by the dollar amount invested. 

Of course, the cost is only part of the conversation. To help investors with the difficult task of ETF selection, it is helpful to also know and understand other ETF selection criteria that can be used to screen and select the best ETFs from the rest. 

Major ETF Selection Criteria

Most investors assess a handful of ETF characteristics to better understand each product, how appropriate it may be for a strategy and ultimately decide which to allocate to. Some of the most common characteristics/metrics investors should also investigate beyond costs include:

Fund Size is simply the assets under management. This is important because if a fund has sufficient assets under management it is less likely to be at risk of a liquidation.

Fund Age is how long an ETF has been around. While new ETF’s are not necessarily bad investments, ETF’s that have been around for a longer time frame has a track record that can be assessed for things like tracking difference and tracking error.

Performance is another way to say returns that an ETF has generated in the past. While it is backward-looking, combining performance data with tracking difference and error can tell an investor quite a bit about whether the fund is delivering on what is promised.

Liquidity is extremely important and quite nuanced on its own. Liquidity is broken into both liquidities of the ETF but also of the underlying securities that make up the basket represented by the ETF. When an ETF is highly liquid it can be easily traded and helps to minimize the costs associated with the transaction. It should be noted that liquidity changes over time and higher volatility periods can negatively impact liquidity so taking that into account is also important.

Replication Method refers to how an ETF tracks the underlying index. There are three main replication methods including full physical replication, synthetic replication, and sampling replication. Each represents a different index replication strategy and knowing what the strategy is can help determine additional potential underlying risks.

The strategy is self-explanatory but careful attention should be paid beyond just the name of an ETF. Investors should look under the hood of the ETF to understand exactly what the underlying basket of securities is and how those securities trade. Again, ETF’s can be efficient ways to get exposure, but understanding and confirming an ETF’s strategy will ensure that investors get the exposure they intend within their portfolio.

State of the Stock Market – Big Sectors Hold Strong

The broader market may not seem bullish right now, but there is clearly a bull market somewhere within stocks. In particular, the S&P 500 and Nasdaq 100 are currently within five percent of all-time highs, which were hit just five weeks ago. Moreover, they held well above their early June lows during the August dip and are clearly in uptrends overall. This tells me that there are pockets of strength within the S&P 500, serious pockets.  

Read More

The chart below shows the six biggest sectors in the S&P 500, which account for some 78% of the index. First, note that the Technology SPDR (XLK), the Consumer Discretionary SPDR (XLY) and the Communication Services SPDR (XLC) hit 52-week highs in late July. Second, notice that these three held above their early June lows during the August pullback. These sector price charts still sport uptrends and still support the uptrend in the S&P 500.

The Financials SPDR (XLF) and Industrials SPDR (XLI) were hit harder in August as both tested the early June lows (green lines). However, they did not break these lows and bounced off these support zones on Thursday. Thus, XLI and XLF, while not as strong as the first three sectors, have yet to break important support zones. And finally, the Health Care SPDR (XLV) is neither here nor there because it has been flat for the last ten months.

Weekly Global Asset Class Performance

If you have any questions, please feel free to email me at


STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)

Most Business Owners Have No Succession Plan or Exit Strategy

By Scott A. Bishop, MBA, CPA/PFS, CFP

Are you a business owner without a complete and coordinated Succession Plan?  If so, please attend our workshop on September 26, 2019 (invitation via the link or below):

Invitation:  Succession Planning and Life After The Sale

For decades, vast wealth has been created for millions of Americans through growing private businesses. However as business owners, especially Baby Boomers, reach the later stages of their careers, a new study by US Trust shows that the majority do not have a formal succession plan or Exit Strategy.

U.S. Trust recently released its 2016 US Wealth and Worth Survey, which sampled a group of millionaire business owners with at least $3 million in investable assets.  In this study, nearly two-thirds of business owners do not have a succession plan (which could include either a sale or transfer of the company). Since most of the business owners rely on their businesses for income, the lack of such planning means that their main source of income could be in jeopardy.

Additionally, the results showed many owners have failed to think about the future of their businesses beyond their own lives. Only 16 percent plan to pass the business on to their families, and 63 percent of older business owners (those over

50) have no formal succession plan. In addition, the majority of business owners have not formulated a strategy for ensuring the highest possible valuation of the business or its continuity beyond the life of the current owner.

Many business owners, whose finances and identity are so closely tied to their

companies, simply don’t want to think about giving them up. According to the report, three-quarters of the millionaire business owners founded their companies and only 8 percent inherited them. Thus, most are first-generation businesses.

Without a plan, many may intend to simply work well past retirement age.

Many entrepreneurs never plan to stop working or they wait until they are ready to retire (not a good plan – what if the unthinkable happens). Others have a plan in mind that they may or may not have even communicated to key stakeholders, but leave its execution to chance by not formalizing it. In my experience not having a formal plan leaves a very low likelihood of an optimal transfer or sale of the business.

In my 20 years of experience, I find that succession planning is a crucial part of long-term business planning that helps prepare for a smooth, strategic exit by the owner or for an unexpected change in circumstances, such as illness, disability or divorce.

Five Key Elements of a Succession Plan or Exit Strategy

The benefits of a thoughtful Succession Plan or Exit Strategy are vital to all stakeholders, whether they be the founder, the employees or the clients who have placed their trust with the firm. When they’re ready to transition, the business owners are uniquely positioned to capitalize on the value of the firms they’ve built.

The majority of business owners I work with are focused on ensuring that the businesses they’ve built will endure—they want to create a lasting legacy. But they are not always sure how to pursue that goal – especially when there is just one owner (with multiple partners, I find that it can be a little easier…but not easy).

It’s for that reason, I believe that business owners need to think through five key considerations necessary to create a successful plan and exit strategy. These elements will benefit the company’s owner(s), whether their goal is internal succession, external succession or a combination of both.

1.  Create a Clear Vision

The initial challenge business owners face when developing a plan is to actually understand where to start. There must be a willingness to look closely at personal and professional goals, and an ability to look impartially at the value of their company. Rather than asking what a successful succession plan looks like, a better question for the founding principals would be to ask themselves “What does a successful transition look like—for me?”. Getting to that answer requires personal reflection and careful consideration. Please note that if there are multiple owners, each owner’s goals need to be accounted for. Setting personal, professional and firm-related goals will help create a clear vision for the owners and the firm, as well as an improved peace of mind for employees, clients and other stakeholders.

2.  Determine The Business Valuation

There are many approaches to determining a firm’s value. But operating cash flow (typically viewed as Earnings Before Interest, Taxes, Depreciation, and Amortization or EBITDA) is the common denominator used to establish fair value. Unlike book value, revenue or net income, cash flow is the best indicator of company profitability and overall operating efficiency. Prospective buyers want to see dependable, growing and predictable flows. Quality of cash flow matters, too. Buyers typically pay a multiple (or measure of equity or firm value relative to revenue or earnings that it generates) based on the quality of cash flow and its growth rate.  Companies will fetch  top  dollar  for  such  things  as  a  stable  client base; revenues that are overwhelmingly from a recurring business; a track record      of growth and strong margins; and a core group of professionals who are committed and incentivized to operate the firm as the founders reduce their responsibilities and ownership stake (a.k.a. Key Employees).

Many firm owners may either want a quick exit or may want to retain a degree of control in a transition – either can also impact valuations. It’s worth considering bringing in a valuation specialist or transaction intermediary to review the mix of goals, revenue streams, expense structure, legal structure, finances, clients and other available information. A specialist can help ensure that a fair and realistic firm valuation is achieved. While there are many approaches to valuation, attributes that are always considered include risk, scalability, growth, and cash flow quality. It is also time to clean up the books. As any valuation is dependent on EBITDA, it is important to make sure that the books and records are in good shape. For that, I suggest a review and/or audit by your CPA firm.

3.  Maximizing Value

Buyers place a high value on business continuity—assurances that clients and key employees will remain in place once the firm begins its transition. Clients who can easily follow disengaged staff out the door are an obvious risk to a successful transition. This risk can be mitigated by hiring key employees and professionals who are a good long-term fit and by creating a compensation strategy with incentives that help employees share in the firm’s success. Creating a structure that allows key employees to participate in ownership is a powerful value driver in successful business succession planning.

Firm value is also enhanced by institutionalizing client relationships—which means ensuring that clients are connected to the firm rather than to any individual employee (or even the owner). Additionally, firms can reduce risk and maximize value by documenting all processes, including compliance procedures and contingency plans. Firms that demonstrate systematized business practices will yield higher valuations than those without this level of transparency.

4.  Maximize Scale

Efficiency is another key value driver. It’s worth exploring ways to facilitate growth without adding fixed overhead. Not only do strong margins benefit owners in the short term but they can also serve as a platform for future firm growth—always appealing to prospective buyers. But there’s an important distinction to be made here: While the efficient operation is desirable, being lean to the detriment of staff workload and compromised client service is not. Buyers aren’t necessarily seeking a bargain, but they do want lower transaction costs per unit of revenue. Efficiencies can be created, for example, by automating workflows to streamline operations and by creating a segmented service offering that fits the revenue profile of each client segment. Creating proportionally lower costs will equate to higher margins and drive EBITDA and possibly the multiple you receive even higher.

5.  Demonstrate Consistent Growth

Buyers will pay a premium for firms that are rigorous about new business development and that have an effective customer growth strategy. The most sought-after companies have multi-tiered growth strategies that utilize customer referral, cross-selling (where possible), marketing, and public relations programs to capture customer revenue opportunities from a number of different channels. Successful firms tend to have well-documented business development compensation and incentive plans in place for the entire staff, to ensure that everyone has a vested interest in the firm’s growth.

Today’s business owners have spent their careers building firms on a foundation of successful relationships, the entrepreneurial spirit and the desire to grow and expand. Establishing a succession plan that secures their firm’s legacy beyond the founder’s working life is critical not just to their firm and their clients but also to the long-term success of the next generation of leadership. The succession planning process can take as many as five to 10 years to establish and implement—and there’s just one chance to get it right…having a plan that works for you, your family, your employees, and all stakeholders.

Understanding the many factors that influence a succession plan is the first step. Business owners who take the long view by starting to address their risks, scalability, growth and cash flow, will see their efforts pay dividends when it is time to implement their exit strategy (whether solicited or unsolicited).

If you want to hear more on these ideas, check out two of my interviews from my radio show, The STA Money Hour (on 950AM KPRC Radio, weekdays from 1 pm to 2 pm Central Time):

Interview:  Alex W. Howard, CFA, ASA

Interview: Jennifer Mailhes, CPA

Important Disclosure:
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.


Contact STA

Thank you for your interest in STA Wealth Management!

Whether you are looking for someone to partner with you in protecting and growing your assets, or you are an experienced financial advisor interested in joining the STA team, we want to hear from you. Please call us or email us, and we’ll be in touch as soon as possible!

Houston Headquarters

CityCentre One
800 Town & Country Boulevard, Suite 410
Houston, TX 77024



Sugar Land Office

Granite Tower
13131 Dairy Ashford, Suite 150
Sugar Land, TX 77478




For directions to our Houston office, click here.