How to Choose an ETF That's Right for a Portfolio

Note: This article is courtesy of

By Marie Dzanis

Exchange traded funds (ETFs) offer investors compelling reasons to use them to build an entire portfolio, or “fill in the blanks” of a developed portfolio for those who want to further diversify. But how to choose the fund or funds that are a perfect fit — either within your current investment plan or with each other? With more than 1,600 funds to choose from, plus hundreds of indexing approaches, it can be a daunting task. Here are some guidelines for investors who are interested in a long-term strategy.

First, determine your objectives

All solid investment decisions begin with determining your goals. Growth is always a major goal but, depending on your circumstances, you may also seek to generate income or mitigate the risk already inherent in your portfolio. Finally, though you are investing for the long haul, you may find that a shorter term need for liquidity arises. Your goals will help you decide what type or types of ETFs to pursue.

Diversification should always remain a goal, of course. Decide which part of the market you want to be in. If you have developed a classic stock-and-bond portfolio, you may look to diversify with real estate or commodities, for instance. Or, you may need to further diversify the mix of industry sectors to bring your portfolio back into your planned balance.

Do your homework

All ETF sponsors make available detailed fact sheets on each of their funds. Once you’ve made the list of funds that can potentially meet your investment goals, compare features such as size (assets under management, or AUM), top holdings (including their geography, market cap, sectors, etc.), dividend information, fees, expenses, risks and other key points to ensure that the ETF meets your investment goals and has strong potential for long-term appreciation.

You should also understand how the ETF and its underlying index are constructed. ETFs use a wide variety of weighting schemes, each of which can affect performance in different ways. A majority use market capitalization as their approach to fund design. These funds track a broad stock market or a particular industry sector. A theme-based ETF on the other hand balances large cap and small cap stocks. Another method, equal weighting, “tilts” toward small cap stocks in the fund by assigning weights to various stocks based on their importance in the sector.

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