Exchange traded funds (ETFs) are swiftly moving into “household name” territory, but not everyone believes the hype. For those skeptics, the remedy is often just a little education.
ETFs provide access to a segment of the market and helps in constructing and managing a diversified portfolio, Roger Nusbaum for The Street summarizes. If you want to invest in a specific area, you’ll need need a fund or some stocks – let’s make the argument for funds. [ETFs: A Portfolio Diversifier.]
A number of factors go into how an ETF performs and represents its market segment.
Some ETFs may not perfectly match a segment of the market since there may be disproportionate weightings of individual stocks within a fund. For example, PowerShares NASDAQ-100 (NASDAQ: QQQQ) has a 20% weighting in Apple (NASDAQ: AAPL). Whether that’s bad or good depends on you: What’s your risk tolerance? Would you rather have equal weight? Or do you already own Apple stock?
But purchasing an individual stock comes with the risk of picking a dud that underperforms the entire segment of the market. [You, the Retail Investor, Are Using More ETFs.]
Some ETFs also have heavy weightings in certain sectors, which need to be considered in the big picture of your portfolio. Market Vectors Russia (NYSEArca: RSX) has a nearly 40% weighting in energy, making it less than ideal if you’re already holding something like United States Oil (NYSEArca: USO). Many single-country emerging market ETFs are heavily skewed toward natural resources; if you’re already holding commodities, you might have to do some adjusting.
Other ETFs have unique strategies that can have an impact on returns. The most recent example is when commodity ETFs were criticized for losing money as a result of contango. It’s a reminder to investors that they should never purchase what they don’t fully understand. We have a number of educational articles on our site, and the ETF providers are always available to answer further questions, as well.
To dig down into nearly any ETF, visit the ETF Resume, where you can find a prospectus, fact sheet, customizable charting and much more.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.