Exchange traded funds (ETFs) are similar to a single stock in the way that investors trade them, but after that they are not all the same. But there are some things about ETFs that investors should know that aren’t always readily obvious.
An ETF By Any Other Name… The most important thing an ETF investor must be aware of is that the ETF in which they are investing may or may not track what the title of the fund implies. It is important to check the holdings of an ETF to see what the index is actually tracking.
David Penn for Yahoo Finance explains that if an investor wants to invest in the price of oil going up, then it makes more sense to invest in an ETF that invests directly in the price of crude oil. A common misconception is to invest in an ETF that tracks the price of oil stocks such as Energy Select Sector SPDR (XLE). Actually, if oil exposure is what you’re actually going for, the better approach would be to invest in United States Oil Fund (USO), which tracks the price of West Texas internediate crude oil using futures contracts.
Heavyweights. Another important idea to consider is the weighting of the ETF. Some ETFs are so heavily weighted toward a few stocks that traders may not get the sector diversification that they think they are getting when they buy the fund. And consider the country weightings, too. Some “international” funds can have hefty weightings in the United States. This isn’t good or bad – it’s just up to you to consider whether that exposure was what you had intended.
The transparency of an ETF makes figuring these concepts out easy, and to figure out which fund holds what, many providers list the companies and weightings out on their fund pages.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.