Five Ways to ‘Kick the Tires’ on Your ETF

With the vast array of exchange traded funds (ETFs) to choose from, they continue to remain attractive, and for good reason. But that doesn’t mean you shouldn’t do your due diligence when choosing funds for your portfolio.

At the end of August, there was $674 billion in 858 U.S.- listed ETFs. One of the main reasons they’ve exploded in popularity is because they offer many investor-friendly characteristics:

• They offer transparency, so you know what you own at all times.
• They’re flexible and can be traded intraday like a stock.
• They offer instant diversification; instead of picking one stock, an ETF will give you exposure to dozens or hundreds.
• On average, their fees are lower than those of mutual funds.
• They enable you to reach “hot” markets such as currencies, commodities and developing countries.

This doesn’t mean that ETFs don’t come with drawbacks, says John Spence at MarketWatch. That means that there are certain things you should consider while you decide to buy. Here’s Spence’s list:

• Consider the overall costs of buying and selling ETFs – not just the expense ratio on the fund itself.
• Check out the tracking error and liquidity by examining the bid-ask spreads and the fund’s trading volume.
• Consider the sector allocations in your stock ETFs; sectors typically can drive long-term performance.
• Leveraged and inverse ETFs require special knowledge and understanding. They’re not for everyone. Learn about how they work by reading our special report.
• Bond ETFs also require examination, because tracking error and bid-ask spreads can be wider than in stock ETFs. (Why it happens).

There are many ways to examine ETFs – here’s a list of more things you can do. Most important of all, however, is to have a strategy. We monitor the 200-day moving average as a signal of when to enter the markets and when to exit. You can read more about the strategy in The ETF Trend Following Playbook.

For more stories on ETF strategy, visit our trend following category.

Kevin Grewal contributed to this article.

Comments

[TraderRob:]

I hear a lot of people ranting and raving about the drawbacks to leveraged and inverse ETFs because of the imperfect match to their target returns, but they do serve an incredibly useful purpose and perhaps are catching too much flack. ETF managers must enter and exit positions held to achieve returns equal to the target and simultaneously manage the price of the fund to reflect the demand for the ETF itself. It's not uncomon to see issues with the commodity ETFs as well, since the spot price of the ETF reflects spot prices of different futures contracts which must reset at the end of each month, causing for a gravitational of the ETF price higher or lower to match next months contract going rate.

All said it's not a perfect instrument, but the levergaged ETF offers the benefits of an aggressive vehicle without the interest from buying on margin and the inverse funds allow a trader to short an industry with a loss limited to the value of the share, as opposed to unlimitted losses from a short position.

Besides, whether a fund reaches exactly 200% of the movement in the target index or asset over a days time shouldn't make or break your trades. The true risk comes from long term positions in ETFs which tend to wash out desired performance based on the daily resetting of the assets held by the ETF managers.

As always, trade at your own risk...

Nov 13 01:10 AM

[cyclingscholar:]

Type in the ETF ticker symbol at yahoo finance, and don't forget to look on the left hand column for 'components.' It'll tell you the top ten holdings in the ETF by market value; useful in comparing similar etfs, and seeing where your money is really going.

Nov 13 02:59 PM

[Papasmurf:]

www.youtube.com/watch?...

Nov 16 10:54 AM