After we have set up our brokerage accounts, we need to figure out what ETFs should we actually purchase. The reality is there are thousands of ETFs out there, and it can be mind-boggling to seek out good ETFs from the array of choices. Once again, the key is really to determine what your investment objective is. Trading ETFs short term and investing ETFs long term have vastly differing strategies. For the purposes of this mini-course, we will cover the mid-long term investment objective.
Here are some factors you may wish to consider when you are trying to find a good ETF:
1. Trading Volume – The volume of shares traded is an accurate indicator of its liquidity. Generally speaking, an investor or trader will prefer ETFs with high liquidity. The reason is because ETFs with high volume traded will decrease the bid-ask spread of the share. Bid-ask spread is the difference between the price at which a buyer wants to buy and a seller wants to sell. If the difference is vast, this means that you are less likely to move your shares when you want to sell them in the future. This is also one reason why the good ETFs will remain popular for long periods of time.
2. Size of ETF – You do not want to plow your money into just any ETF. It should also have a large amount of assets in holding. An ETF that has a net asset value of below $10 million likely means that it is not very popular with investors. This will eventually turn into illiquidity and wide spreads.
3. Diversification – One of the key advantages of investing in ETFs is its ease of diversification of assets. Whenever you buy an ETF, think about how this would add diversification to your current portfolio. For example, if you would like to diversify your portfolio greatly, you might want to purchase an ETF that covers a broad index.
4. Expense Ratio – Before you make your investment, you need to consider your costs. An average ETF carries an expense ratio of 0.44%. This means that a $100,000 invested in ETFs will cost you $440 in fees per year. Mutual Index Funds on the other hand can roll up to as high as 1-3%. When choosing your ETF, it is advisable to pick one that has a low expense ratio. However, not all ETFs are the same. There are many unproven, unorthodox ETFs which might incur high expense ratio. New investors should generally avoid such plays.
This introduction covers the 4 basic ways to find good ETFs. Of course, as you become more experienced, there may be other attributes of an ETF which you might include into your selection criteria. The bottom line is you have be familiar with the ETF which you are investing so that it is aligned to your long term objectives. An investor needs to take the holistic approach and be tolerant of short term volatility to take full advantage of exchange-traded funds.