As exchange traded funds gain ground in the markets, many have found ETFs to be an efficient, cheap and easy-to-use investment tool. However, ETFs come with their own set of factors to keep in mind.
For instance, Daniel Solin for U.S. News points out that transaction costs can add up. Since ETFs trade on the major stock exchanges and investors can buy and sell ETFs like any regular stock, trading fees can add up.
Investors will incur an up front commission fee, and traders should be aware that ETFs can incur implicit costs from a wide bid-ask spread. [The Total Costs of Owning, Trading ETFs]
Nevertheless, some brokerage firms have partnered with ETF sponsors to offer commission-free trades on certain ETFs. The commission free trades should help investors cut down costs when regularly rebalancing their portfolios. [Six Popular Commission-Free ETF Trading Platforms]
ETF investors should also monitor their exposure. There are a number of specialized, niche ETFs that target specific countries and sectors. While it may be nice to profit off a move in a specific area of the market, investors should not go crazy in overweighting a single area of the market.
Additionally, there are a number of so-called geared, or leverage and inverse, ETFs available. These ETFs promise to generate multiple or opposite returns of a target market. However, these leveraged and inverse are highly volatile, incur high costs and are less tax efficient than traditional ETFs. Furthermore, due to compounding issues, leveraged and inverse ETFs may also deviate from their target strategies over the long-term. The geared ETF strategy is not for the uninitiated. [For the Adventurous, These Leveraged ETFs are Working]
For a simple investment portfolio, investors should consider broad and cheap index-based ETFs. For instance, there are a number of ETFs that track broad market indices, like the S&P 500, or funds that cover the total stock market. Additionally, the cheapest broad sock ETF only has a cheap 0.04% expense ratio.
In the bonds space, fixed-income investors can diversify with both domestic and international bond ETF options. Traders can also break it down further and target corporate bonds, municipal debt or government-issued Treasuries.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.