Intro
ETFs, like mutual funds, are baskets of individual equities. However, ETFs may be freely traded similar to stocks, whereas mutual fund transactions don’t occur until the market closes. Many ETFs are passively managed and are linked to an underlying index or market sector. Due to this, their expense ratios are often lower than those of mutual funds. Active management is more common in mutual funds. On the other hand, ETFs, which are passively managed, have a greater chance of beating index returns because active management does not frequently outperform indexes. In that sense, ETFs arguably offer a superior alternative to actively managed, higher-cost mutual funds.
After their widespread introduction in the early 2000s, exchange-traded funds (ETFs) have seen a dramatic increase in popularity and number. The creation of the investment vehicle has been beneficial to investors since new low-cost opportunities now exist for almost every asset class on the market. Today’s investors must sort through more than 5,000 ETFs across more than 80 countries to find the right EFT, and this is not an easy task to take on. So, how do you find the right ETFs? We have got some tips for you.
Tips to Find the Right ETF
When finding the right ETF, you must have multiple factors considered beforehand.
Narrow down your choices:
There are a plethora of ETFs to choose from. Traditional index ETFs track benchmark indices in bonds, ETFs based on investing style, and others. While these are some of the most common types of EFTs, there are even more options for skilled investors. Inverse ETFs that rise when the market falls and inverse ETFs that fall when the market rises are two types of ETFs that provide returns based on the underlying index’s movements. These EFTs are preferred by highly skilled investors who know what they are doing. At the moment, there are currently over 2,000 ETFs available on US exchanges with combined assets under management of more than $5 trillion.
If you want to invest in an ETF, the first thing you should do as an investor is narrow down this wide range of ETFs and focus on ones suitable for your portfolio and long-term investment plan. For this, there are several options available to you. You can start by using an asset screener to reject anything undesirable, such as inverse or leveraged ETFs. Or, you can go through each ETF and analyze their core vitals. No matter what you do, it’s essential to develop a filter that can help you narrow down stocks.
Understand that the ETF market is competitive:
The ETF market is highly competitive. This has generally been beneficial for investors, as it has driven the expenses associated with ETFs down to near-zero levels, making them low-cost and efficient securities.
However, the competition has also brought in some less-than-ideal practices. To distinguish themselves from the competition, some ETF managers have launched funds that are predominantly focused on a specific topic or on a fad that may not last. And believe it or not, several of these ETFs are available in the market.
The recently debuted Robotics & Artificial Intelligence ETF (BOTZ) is one example of an ETF that tracks hot investment trends, as is the Drone Economy Strategy ETF (IFLY). An Obesity ETF (SLIM) invests in firms dealing with obesity or obesity-related illnesses. Therefore, make sure you understand what you are getting on when signing these funds.
Picking the right ETF
Given the host of ETF alternatives that investors must confront, it’s critical to think about the following elements:
Level of Assets:
An ETF should have minimum assets to be considered a viable investment option. The standard criteria for an ETF are at least $10 million in assets. A low level of assets signals lower investor interest, implying that the liquidity and spreads will be limited.
Trading Activity:
An investor must consider whether the ETF in question is traded in significant volume. For some of the most popular ETFs, trading volume is measured in millions of shares per day, while others barely trade at all. Regarding liquidity, trading volume is a good indicator, regardless of the asset class. Generally, the greater the trading volume for an ETF, the more liquid it is likely to be and the smaller its bid-ask spread will be. These are especially vital factors to consider when deciding whether or not to sell an ETF.
Underlying Index or Asset:
Consider the index or asset class on which the ETF is based. When it comes to diversification, investing in an ETF based on a broad, well-known index rather than an obscure index with a narrow industry or geographic focus may be preferable.
Tracking Error:
While most ETFs follow their underlying indexes closely, some do not. Generally, an ETF with a lower tracking error is preferable to one with a greater error.
Market Position:
In the ETF world, a first-mover advantage is critical. This is because the first ETF provider in a sector has a good chance of capturing the lion’s share of assets before others jump on the bandwagon. It is prudent to avoid ETFs copying an original concept because they cannot distinguish themselves from their rivals and attract investors’ funds.
Investors must carefully consider several factors when they are picking the right ETF. These include the level of assets, trading activity, underlying index or asset class, tracking error, and market position. While investing in the right ETFs can help investors realize massive yields at low costs, the opposite could also happen. Despite the low levels of volatility attached to ETFs, it’s essential to do your research before you start investing.
