As an investor stumbles upon the nifty exchange traded fund investment vehicle, there are some basic steps to take to pick out the best ETF.
ETFs allow investors to diversify a portfolio by accessing a broad number of companies or securities from a range of asset categories. The investment tool is cheap, tax efficient and easy to trade.
Nevertheless, no two ETFs are created the same, so investors should still do their due diligence before picking one out. For starters, less expensive ETFs may be a better bet, Simon Moore writes for Forbes.
A number of academic studies have shown that lower fees or costs have shown to, on average, lead to improved performance. Most ETFs are passive products so they just simply track an index, and the process is more or less automated so costs are depressed. With less fees to dish out, an investor has more left over to grow their wealth.
Avoid wide spreads. Since ETFs trade like stocks on a stock exchange and may be accessed through a traditional stock brokerage account, traders will also keep in mind the bid/ask spread on trades, which may indirectly eat away at your total returns. While investors may not need to worry about trades on large and popular ETFs with tight spreads, less popular ETFs with lower trading volumes may show wide spreads between the bid and asking price.
Securities lending may be the icing on the cake. ETF issuers may engage in securities where they charge a fee to allow traders to borrow shares from an ETF, and this charged fee may be returned back to an ETF investor or even offset the fee of the ETF itself. Consequently, it is beneficial to invest in an ETF issuer that has a shareholder friendly securities lending policy.
Consider commission-free ETF trades. Since investors have to access ETFs through a brokerage account, one may further reduce costs through commission-free ETF programs. However, not all brokerages have a commission-free ETF program or have similar list of commission-free offerings. If you are a long-term, buy-and-hold investor, commission free trades may not be as important as the expense ratio, but for those who may be more active, commission-free trades help cut down on costs.
For more information on ETFs, visit our ETF 101 category.