There are over 1,400 exchange traded funds that are currently trading. The following guidelines can help investors weed out any duds and pick an ETF that is right for their portfolio or investment goals.
Some of the best ETFs trading have at least one or more traits in common with the others. There are four major points of reference that investors can look into that will help streamline the process of choosing an ETF, reports Dan Caplinger for The Motley Fool. [Steps to Work Out Your ETF Core]
- Low fees are the most cost-effective feature of an ETF. The low cost of an ETF means that more principle is saved for direct investment, rather than lining an active manager’s pocket. Plus, over the long term, saving on annual fees adds up and can be a determining factor in capital gains or losses. [ETF 101: Benefits and Considerations]
- Strategy is an important characteristic. Since an ETF is generally a passive tool that tracks in index, the approach of the provider is important. Some ETFs use a traditional market-cap weighted index that focuses in on the highest income earning companies. However, fundamental indexing has come into the spotlight lately, and creative strategies such as equal weighting or earnings have helped some investors beat the broad market. Some of the more creative funds do cost a bit more than a traditional, passive benchmark-tracking ETF so be sure to weight the cost over benefit.
- Liquidity is one of the most telling features that an ETF is healthy. The number of shares that are traded in a day is important because an ETF must be liquid for an investor to trade it. An ill-liquid fund may incur losses should an investor decide to sell, and if an investor buys a thinly traded ETF they may pay more than it is worth. A long term buy-and-hold investor does not have to mind this factor as much, since lack of liquidity does not eat into the returns of a current investment.
- A track record of about 3 years is important for investors to refer to. An investor can measure how well an ETF’s benchmark has followed the corresponding market or sector. This is important for ETFs that use special derivatives or futures in the commodity market, since returns vary greatly from the physical commodity. Overall, if an ETF can not do what it was created for, why bother? [How Smart Beta ETFs Fir Into A Portfolio]
Tisha Guerrero contributed to this article.