Exchange traded funds (ETFs) are a good way to round out your portfolio or get exposure to specialized areas of the market. But with hundreds of choices out there, how can you be sure you’re choosing the right fund for you?
Cost. The best thing to consider when sizing up an ETF is the investment trading cost. This is the most commonly overlooked aspect and when trades rack up, they cane at into principal. Some ETFs can be expensive to use because they sell at hefty premiums or discounts to the values of their portfolios, which became all too clear during the market turmoil, says Stan Luxenberg for Registered Rep. [The Cost of High Fees.]
What It Tracks. If liquidity or other costs are a concern, look for funds that track a well-known benchmark. Funds that track exotic indexes may trade at times at a premium or discount to the net asset value (NAV), an event that can be heightened when the markets hit turbulence. [How to Find the Right ETF.]
Size. Individual investors should look for ETFs that have greater trading volume; there’s no exact number to keep in mind, however, because it depends on the size of your trade. If you’re doing a large trade, execute it in small blocks to avoid moving the price too much and use limit orders to control what you pay.
Holdings. How is the ETF allocated? Some funds are heavily weighted in their top three or four holdings; others are spread out evenly across dozens of holdings. Ensure that the weightings a given fund has are the weightings you’re seeking. [The Pros and Cons of ETF Investing.]
Strategy. You’ve found your ETF and it’s time to buy. What’s your strategy? A simple one we use is following the trends. By using the 200-day moving average to determine where and when you’re in and out of the markets, you’ll help minimize the impact your emotions could have on your portfolio and limit costly mistakes. [Read The ETF Trend Following Playbook for more on this strategy.]
For more 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.