How to choose an exchange-traded fund

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November 04 2019
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Exchange-traded funds (ETFs) are low-cost, long-term investment options with a wide spread, which means instant diversification for investors. However, it is still important to choose an ETF that is appropriate for your portfolio.

Here’s what to consider when choosing an ETF.

How to choose an ETF

ETFs typically track an index, sector or specific theme chosen by the fund manager. This makes each ETF somewhat unique despite striking similarities. To figure out which fund fits your portfolio best, compare the following features of your shortlisted ETFs.

Assets

Read the product disclosure statement to find out what type of assets the ETF holds.

ETFs can hold equities, fixed-income assets, physical properties, real estate investment trusts, other ETFs or a collection of various asset classes.

Whatever the fund holds can potentially determine its liquidity and risk exposure.

Liquidity
Liquidity refers to how fast and/or easy it is to turn an asset into cash – or how fast you can get the money if you decide to sell the asset.

The ETF’s underlying asset class may determine its liquidity, which is important if you want to ensure that transactions will be fast if you want to buy and sell your ETF units.

Risk exposure

Different asset classes are exposed to, and weakened by, different risks.

For instance, market volatility can heavily affect shares and equity assets, but fixed-income assets are more affected by interest rate movements. Consider what risks your current portfolio is already exposed to and try to choose an ETF that can soften its effect.

Currency
International ETFs are exposed to movements in currency, especially if the underlying assets are invested in emerging markets.

Avoid simply looking at the ETF’s market price because this doesn’t necessarily reflect your gains. Remember that international ETFs are purchased in the country’s local currency, so an economic slowdown in the local market may depreciate the value of your investments.

Investment strategy

The fund manager’s investment strategy can increase or decrease an ETF’s exposure to risk.

No matter how attractive its profits seem, make sure to consider whether an ETF matches your own investment objectives before adding it to your portfolio.

Track record

Past performance is not indicative of future performance, but it may show how well the fund manager handles the fund.

Likewise, look into the fund manager’s relationship with its clients. For instance, does the manager inform clients when the fund’s strategy changes and are they open about the ETF’s tracking error?

Making informed decisions is important, especially when it comes to finances, so choose a fund manager who will equip its clients with the necessary information that can help them decide.

Features

Some fund managers offer extra features in their ETFs, such as automatic reinvestment or automatic withdrawal of profits.

Consider asking about any features that other fund managers offer. Compare the different features and select the fund that can offer features that best fit your circumstances.

Transaction costs

The more you pay in fees, the less you get to keep for yourself.

ETFs are generally low-cost funds, but some fund managers still charge higher than others regardless of their fund’s performance.

ETF managers typically charge annual fees and brokerage fees. The former is a fee for managing the fund and its underlying asset, while the latter is a fee you pay for each buy and sell transaction.

Since most ETFs are designed for long-term investing, brokerage fees tend to be higher than management fees. Active trading may make ETFs more expensive.

Make sure to consider how much you will be paying in fees so that you can ensure that the profits your ETFs generate goes into your pocket rather than canceled out by fees.

Explore nestegg for more information about investing.

About the author

Louise is a content producer for Momentum Media’s nestegg who likes keeping up-to-date with all the ways people can work towards financial stability in 2019. She also enjoys turning complex information into easy-to-digest, practical tips to help those who want to achieve financial independence.

About the author

Louise is a content producer for Momentum Media’s nestegg who likes keeping up-to-date with all the ways people can work towards financial stability in 2019. She also enjoys turning complex information into easy-to-digest, practical tips to help those who want to achieve financial independence.

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