Topic: ETFs

The best ETF to buy have these key characteristics

5 ways to know you’re picking the best ETF to buy

One way to invest in stock markets is to buy exchange traded funds (ETFs) that track major stock indexes. ETFs trade on stock exchanges, just like stocks. Prices are quoted in newspaper stock tables and online. You must pay brokerage commissions to buy and sell ETFs, but their low management fees still give them a cost advantage over most mutual funds.

As well, shares are only added or removed when the underlying index changes. As a result of this low turnover, the best ETF to buy won’t incur the regular capital gains bills generated by the yearly distributions most conventional mutual funds pay out to unitholders.

We still feel that investors will profit the most with a well-balanced portfolio of high-quality individual stocks, but ETFs can also play a role in a portfolio. And the best ETFs offer very low management fees and well-diversified, tax-efficient portfolios of high-quality stocks.

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Management expense ratios and ETFs

Management expense ratios are typically much lower on ETFs than on conventional mutual funds because most ETFs take a much simpler approach to investing.

It’s important for investors to research and review the management expense ratio of every mutual fund and ETF they plan on investing in. Is the MER fee higher than other comparable funds or ETFs? Have the fees increased year over year? A fund with a high MER is definitely a negative unless the fund has shown exceptional performance over time. As always, take a long view on MERs and their impact on the overall long-term returns on your investments.

The best ETF to buy will likely be a “traditional” ETF, and not a “new” ETF

We think you should stick with “traditional” ETFs. Traditional ETFs practice “passive” fund management, in contrast to the “active” management that conventional mutual funds provide at much higher costs. Many “new” ETFs also look to add in some active management. Traditional ETFs stick with passive management—they follow the lead of the sponsor of the index.

Sponsors of stock indexes do from time to time change the stocks that make up the index, but generally only when the market weighting of stocks changes. They don’t attempt to pick and choose which stocks they think have the best prospects.

This traditional, passive style also keeps turnover very low, and that in turn keeps trading costs for your ETF investment down.

We think simple is better.

The easier an investment is to explain and understand, the less likely it is to harbour hidden risks and costs that can only work against you. As the old investor saying goes, “Stick with plain vanilla.”

Many “new” ETFs focus on narrower indexes and higher-risk strategies, instead of giving you a low-cost way to copy the results of a standard market index.

The best ETF to buy for the aggressive part of your portfolio can focus on well-established small companies that dominate their markets

You should avoid aggressive growth funds that mainly invest in stocks of companies that hold a lot of concept stocks, or that do a lot of trading, or that delve into options or futures trading.

These aggressive growth funds and stocks are only suitable for investors who can accept higher risk.

Our aggressive selections tend to be more highly leveraged and more volatile than our conservative recommendations, and they can give you bigger gains and bigger losses. This may be due to financial leverage, or to the risk in their industry or particular situation, or our estimation of upcoming changes in that risk. Keep in mind, though, that these or any aggressive investments should make up no more than, say, a third of most investor portfolios.

Ultimately, the percentage of your portfolio that should be held in either conservative or aggressive investments depends on your personal circumstances. An investor with a longer time horizon or without the need for current income from a portfolio can invest some money in aggressive ETFs or stocks.

The best ETF to buy for a small part of your portfolio will offer global diversification

We think conservative investors could hold up to 10% of their portfolios in foreign stocks. One way to do that is to buy carefully chosen exchange traded funds (ETFs) that have an overseas focus.

What resources do you find helpful when you’re looking for the best ETF to buy? Share your thoughts with us in the comments.


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