For all the benefits of having a seemingly infinite number of choices, having countless options can also become overwhelming if you begin to overthink it. The exchange traded fund (ETF) options now number in the hundreds, making it imperative to know how to pick and choose among them. Below, we help you do just that.
At the end of March, there are 971 ETFs available with $819.8 billion in assets under management.
Wow. That’s a whole lot of choice.
The sheer number of funds has led to intense competition to attract investor money, says Elvis Picardo for Investopedia. One way funds have been differentiating themselves is by focusing on very specific market niches, such as shipping or medical devices. Other funds have latched onto hot investment trends such as green energy. There are also home holes in the investment world that have yet to be filled, and first movers may find themselves well-positioned to benefit by closing up the gaps. [10 Reasons to Love ETFs.]
With so many funds available, investors should be keen on identifying a few characteristics that may make or break a fund.
- A fund should have a minimum of $10 million in assets. This ensures that a fund will have ample liquidity and narrow bid/ask spreads. If you’re placing a larger order, contact an alternate liquidity provider. Here’s how it works.
- A fund should have high daily trading volumes. Trading volumes can be as disparate as a few million trades per day to only a few. High volumes ensure liquidity and provide for an easy exit. Again, if you’re a large trader, be sure to contact an alternate liquidity provider.
- From a risk point of view, it may be wise to invest in funds that track a broad index rather than an obscure index. But if you want more risk, then do consider narrower funds – just have a stop loss in effect. [Not All ETFs Are Created Equal.]
- ETFs are built to track indexes. All things equal, funds with small tracking errors are preferable to ones with larger errors. [Deciphering Moving Averages.]
- Funds that are the first to track an index are usually preferable to ones that merely imitate the “first movers.” This is because the originating funds will usually attract more investor money, thereby bolstering assets and trading volume and, hence, liquidity.
- Don’t forget about cost. If you’re considering a couple of ETFs that are largely similar, look at what they cost. It isn’t the be-all, end-all, but all things being equal, lower cost is better. [Why Cheap Isn’t Always Better.]
- Where’s your strategy? Before you buy, do you have a strategy in place? If you don’t have one, get one. A simple one we suggest is trend following, which you can learn how to do here.
Sometimes, an ETF will have to liquidate. Generally, the fund will notify its investors three to four weeks before the liquidation. Investors facing liquidation will have one of two choices.
- Sell before the stop-trading date in order to avoid a sharp selloff in underlying assets.
- Hold onto the shares until liquidation, at which point investors will receive a distribution of the sold assets. This will allow an investor to avoid the potentially large bid/ask spreads on the fund’s shares.
By choosing carefully, ETFs are a great way to lower the risk profile of your portfolio and gain broad exposure to a variety of different market sectors.
For more information on ETF fundamentals, visit our ETF 101 category.
Sumin Kim contributed to this article.
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.