For every up, there is a down. Newton’s Third Law is true both in life and with exchange traded funds (ETFs). Not all ETFs are right for all investors, though. How do you decipher which ones are best for you?
Different ETFs serve different purposes. It depends on your risk tolerance, time horizon, investing style and the overall makeup of your portfolio.
For example, leveraged ETFs are great if you’re looking to hedge a position you hold to avoid having to sell it; they’re not great at all if you’re looking for something you can buy and sit on for a few years. Oil is a good investment if you want to capture the gains the commodity has been making in recent months, but it’s not ideal if you’re looking for something with low volatility.
Matt Krantz for USA Today has a few tips on things to look for to determine the ETFs that are your best fit, while we expand on certain areas a little:
- Broad vs. Narrow. Broadly diversified ETFs are a much better bet than an individual stock. But there are also broad and narrow ETFs – the narrow you get, the more sensitive to market movements your ETF may be. If you want to diversify a little more and keep the risk lower, consider broad funds.
- Annual fees. While expense ratios are low for most ETFs, don’t make the assumption that they’re all dirt cheap. Some of the specialized ETFs carry high fees. Be sure to check and compare before buying to see that you’re not paying more than you had intended.
- Know what you own. ETFs that are invested within an industry or a niche market generally carry more risk than a broad fund. It is up to the investor to do some homework and know what they are putting their money toward and what the risks are.
- How does it work? Some ETFs own stocks of a certain market value or size. Others even use complex bets that the stock market will fall. Buying these highly concentrated ETFs can often be very risky – do a gut check and be sure you understand the risks and construction and are comfortable, as well.
- Liquidity. A general rule is that the larger the assets and the higher the trading volume, the better the liquidity of your ETF.
For more educational stories about ETFs, visit our ETF 101 category.
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.