Created in the 1990s, exchange-traded funds have become incredibly popular — ETFs account for over half a trillion dollars worth of investment each year. They are more tax efficient than mutual funds and have lower expense ratios. Various ETFs can make a small or large part of your portfolio, and they come in all different types. Figuring out where to begin can be overwhelming, but here is a guide on how to choose the right ETFs for you:
Choosing what to track The most popular ETFs track indexes like the S&P 500 or the Nasdaq 100. However, you may want to be more specific about your investments. ETFs can also track sectors such as healthcare, agriculture and technology. You can also choose to invest in currencies or individual commodities, like gold or oranges. Some funds may have a narrow focus like auto-immune diseases or alternative energy. While broad-range index investing means a built-in diversity, looking at specialized ETFs can give you more individual control.
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Passive versus aggressive management Most ETFs are passively managed, which means they are set portfolios with minimal intervention. If you would like more involvement, you can choose an actively managed ETF. Active ETFs rely on more dramatic investment strategies, which entail ongoing research, risk management, and trading to try to anticipate and beat market forces to the punch.
Assess the quality of an ETF Typically, ETFs are created by large, established institutions. Nonetheless, it is important to look at each ETF’s salient features to determine its worth. First, you want to make sure that the ETF manages at least $10 million in assets. Usually, having more assets is better because it ensures a healthy amount of investor interest.
The ETF should also have a high level of trading activity. Higher trading volume means more liquidity. Another factor to consider is an ETF’s tracking error. While it is a rare occurrence, some ETFs can make mistakes when tracking their indexes. Opt for the ETF with a low rate of tracking error. Finally, consider the ETF’s originality. The first ETF in a certain sector will likely get the greatest share of assets. Imitative ETFs do not tend to attract investors, and they may point to a financial institution’s inability to diversify.
Some popular ETF families There are hundreds of ETFs out there, but some have consistently stood out from the crowd. Three of the most popular kinds of ETFs are Spiders, Vipers and iShares. Spiders is short for Standard & Poor’s Depository Receipt (SPDR) and primarily tracks the S&P 500 stock market index. iShares is an ETF family by Barclays Global Investors. iShares also track the S&P 500. iShares manages over 25 funds covering domestic and international sectors and indexes. Vipers are ETFs from the Vanguard group, which manages $1.6 trillion in assets. If you are considering an ETF for the first time, looking at these three is a great place to start.