Exchange traded funds (ETFs) are a boon to most investors, as they provide relatively inexpensive diversification benefits and transparency. But knowing which one to buy involves consideration of a number of factors.
The proliferation of ETFs in the investment marketplace has given way to funds of all types and flavors invading the scope. When selecting an ETF, there are basic criteria to look for to have success in your investment. Intelligent Speculator gives us some points to consider when looking at specific ETFs, while we throw in some of our own.
1. The Fees. ETFs do have low fees in general. Always look at the fees, especially when dealing with specialty ETFs or those that invest in emerging markets.
2. Liquidity. The liquidity of the ETF itself is important. Look at trading volume and asset size to determine how liquid your ETF will be. Very liquid ETFs have bid-ask close to one cent. But it’s also important to mind the underlying holdings, as well, and ensure that they have liquidity, too.
3. The Underlying Holdings. ETFs are transparent, making it a cinch to look up what its components are. Consider how many holdings there are, how they’re weighted and how well they reflect your investment objectives.
4. Your Own Portfolio. What do you already own? How well does the ETF you’re considering complement your goals and your existing holdings? Is it a good fit, or does it leave you overweight in a sector?
5. Past Performance. Past performance is no guarantee of future results, but does the ETF work? Does it track its underlying index well?
6. Other Education You May Need. Be sure to consider other things specific to certain types of ETFs. For example, leveraged and inverse ETFs don’t work like traditional ETFs. Active ETFs don’t track an index – how does the active ETF you’re considering operate? Commodity ETFs have certain tax considerations. Be sure to know and understand these things before you buy.
For more stories about ETFs, visit our ETF 101 category.