Choosing the right ETF for your portfolio
1. Objectives/Strategy
One of the first things to look at when considering an ETF is the fund's objectives and investment strategy. Different ETFs may focus on different markets (such as domestic stocks, international stocks, or bonds), industries (such as technology or healthcare), or investment styles (such as value or growth).
For example, the Vanguard Total Stock Market ETF (VTI) aims to replicate the performance of the entire US stock market, making it a good option for investors looking for broad exposure. The iShares Global Healthcare ETF (IXJ), on the other hand, focuses specifically on the healthcare sector and may appeal to investors who believe that industry will outperform.
2. Holdings
Another important factor to consider is the ETF's holdings. This includes both the number and type of securities held within the fund.
Investors should pay close attention to the asset allocation of the ETF they are interested in. If they already have certain securities in their portfolio, they may not want to invest in an ETF that holds similar assets. It's generally a good idea to diversify your holdings to reduce risk.
For example, the SPDR S&P 500 ETF (SPY) tracks the S&P 500 index, which includes 500 large-cap US stocks. This ETF is a good option for investors who want exposure to the overall US stock market. On the other hand, the iShares MSCI Emerging Markets ETF (EEM) holds stocks from companies in developing countries, offering exposure to a different part of the world.
3. Fees
The fees associated with an ETF are a crucial consideration. While ETFs are generally cheaper than mutual funds, some still come with substantial expenses that can eat away at returns over time.
Investors can compare expense ratios across different ETFs to find the most cost-effective option. The expense ratio represents the annual cost of owning an ETF, expressed as a percentage of the investor's assets in the fund. Lower expense ratios generally mean higher returns.
For example, the Schwab US Dividend Equity ETF (SCHD) has an expense ratio of only 0.06%, making it one of the most cost-effective options for investors looking for dividend-paying US equities. The Vanguard Total Bond Market ETF (BND) charges an expense ratio of 0.035%, making it a cheaper option for investors looking for exposure to the US bond market.
4. Liquidity
Liquidity is another important factor to consider when choosing an ETF. Liquidity refers to the ease with which an investor can buy or sell shares of the ETF in the market.
Investors should look for ETFs with high average daily trading volumes, which indicates that the fund is actively traded and the bid-ask spread, or the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept, is low. This helps ensure that investors can buy or sell shares at or near the market price.
For example, the SPDR Gold Trust (GLD) is one of the most popular ETFs for investors looking to invest in gold. With an average daily trading volume of 11 million shares, it's a highly liquid option that can be easily bought and sold.
5. Performance
Past performance is another important consideration, though it's important to remember that it's not a guarantee of future returns. Investors should look at the historical performance of the ETF, paying attention to factors such as volatility and risk-adjusted returns.
For example, the iShares Russell 2000 ETF (IWM) tracks the Russell 2000 index, which includes small-cap US stocks. Its five-year annualized return is 14.95%, which may appeal to investors looking for a high-growth option. However, it's important to note that small-cap stocks can be more volatile than large-cap stocks, which may carry higher risk.
In summary, choosing the right ETF for your portfolio requires careful consideration of a variety of factors including objectives, holdings, fees, liquidity, and performance. By weighing all of these factors carefully, investors can make an informed decision that aligns with their investment goals.