With the vast array of exchange traded funds (ETFs) to choose from, they continue to remain attractive, and for good reason. But that doesn’t mean you shouldn’t do your due diligence when choosing funds for your portfolio.
At the end of August, there was $674 billion in 858 U.S.- listed ETFs. One of the main reasons they’ve exploded in popularity is because they offer many investor-friendly characteristics:
- They offer transparency, so you know what you own at all times.
- They’re flexible and can be traded intraday like a stock.
- They offer instant diversification; instead of picking one stock, an ETF will give you exposure to dozens or hundreds.
- On average, their fees are lower than those of mutual funds.
- They enable you to reach “hot” markets such as currencies, commodities and developing countries.
This doesn’t mean that ETFs don’t come with drawbacks, says John Spence at MarketWatch. That means that there are certain things you should consider while you decide to buy. Here’s Spence’s list:
- Consider the overall costs of buying and selling ETFs – not just the expense ratio on the fund itself.
- Check out the tracking error and liquidity by examining the bid-ask spreads and the fund’s trading volume.
- Consider the sector allocations in your stock ETFs; sectors typically can drive long-term performance.
- Leveraged and inverse ETFs require special knowledge and understanding. They’re not for everyone. Learn about how they work by reading our special report.
- Bond ETFs also require examination, because tracking error and bid-ask spreads can be wider than in stock ETFs. (Why it happens).
There are many ways to examine ETFs – here’s a list of more things you can do. Most important of all, however, is to have a strategy. We monitor the 200-day moving average as a signal of when to enter the markets and when to exit. You can read more about the strategy in The ETF Trend Following Playbook.
For more stories on ETF strategy, visit our trend following category.
Kevin Grewal 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.