An ETF (Exchange Traded Fund) is a pooled investment security that can be bought and sold like an individual stock.
Think of it like buying a salad.
When you buy a salad, you aren’t just getting the salad.
You’re getting everything that comes inside that salad.
The croutons, the tomatoes, the onions, the cucumbers, the sauce and anything else you might want to throw in there.
An ETF can be structured to track anything from the price a commodity to a large and diverse group of assets.
There are ETFs that are even designed to track a specific investment strategy.
Some examples of ETFs you can buy:
Equity ETFs
Bond/Fixed Income ETFs
Commodity ETFs
Currency ETFs
Specialty ETFs
Sustainable ETFs
Real Estate ETFs
Have you ever heard someone say: “There’s an app for that!”
Much like apps, there’s probably an ETF for whatever you’re looking for.
How to Pick ETFs
The first step to selecting the perfect ETFs is understanding your investor profile.
Typical considerations include:
Your age
Your investing knowledge/experience
Your time horizon
Your risk tolerance
Understanding if you’re a conservative, moderate, or growth-oriented investor plays an important role in choosing the right ETF for your portfolio.
Additionally, your age and time horizon will determine what type of holdings you’ll want to own inside your portfolio.
Figure out who you are as an investor before you start making any type of investments.
Here’s what you should be considering when selecting the perfect ETF:
Fund Size ETFs with a low level of assets under management (AUM) can be subject to lower liquidity levels and wider trading spreads.
When I’m looking for an ETF to add to my portfolio, I like to buy ones that have sizeable assets under management to minimize the risk of a future closure and protect me against large amounts of volatility.
Tracking Difference
You would think that if an ETF tracks an index that rises by 10%, the value of your ETF will rise by the same amount.
WRONG.
Tracking difference is the difference between the ETFs performance and that of the index.
Because ETFs are subject to a number of costs, including transaction fees, regulatory and operational costs and Management Expense Ratio’s (MERs), the small difference can become significant over a long period of time, cutting into your profits.
Performance Past performance never guarantees future returns, but as an investor you should be analyzing the ETFs performance over various timeframes and compare it with its benchmark index and other similar ETFs.
Passively or Actively Managed A passively managed ETF will typically have lower fees than its actively managed counterpart. Understanding what type of ETF you’re buying is key to understanding the fees and costs that come with it.
Physical or Synthetic? Physical ETFs invest in the underlying asset of the index and are most common.
Synthetic ETFs do not invest in assets directly but rather track the index through derivatives. These are contracts that are tied to the value/price of the underlying asset.
The Largest ETFs Providers Unlike buying small cap stocks that may have a high upside potential, when buying ETFs it’s usually a good strategy to stick with the Big Boys.
Like a bank loaning money to a developer to build a residential condo, your risk is minimized when you’re dealing with a developer who has successfully completed other projects and has experience doing so.
The 3 largest ETF providers (in order) by AUM are:
BlackRock
Vanguard
State street
Number One Mistake When Buying ETFs
Overlap is a big mistake, especially among new investors, when buying ETFs.
Make sure you know and understand the holdings of your ETF.
Some hold thousands of stocks and some overlap is completely fine, however holding two of the same ETF in your portfolio with similar weightings of similar stocks is overkill and I’d advise against it.
Two Resources to Check Out:
ETF.com is a great website for finding and analyzing ETFs.
It will tell you the ETFs performance, it’s AUM, Management Expense Ratio’s, how many holdings are in the fund, it’s date of inception and you can even compare the performance against other similar ETFs.
I use this website religiously when picking ETFs for my portfolio.
Thanks for reading!
Alex (The Dividend Dominator) Founder and CEO of Dividend Domination Inc.
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Thanks for sharing! This is great info.