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Topic: ETFs

When an ETF investment is the right choice

ETF InvestmentsAn ETF investment can be a great low-fee way to hold shares in multiple companies with a single investment

Is an exchange traded fund investment right for your portfolio? An ETF investment is one of the most popular and most benign investing innovations of our time. ETF investments are a little like conventional mutual funds, but with two key differences.

First, ETF investments trade on a stock exchange throughout the day, much like ordinary stocks. So you can buy them through a broker whenever the stock market is open, and generally you pay the same commission rate that you pay to buy stocks. In contrast, you can only buy most conventional mutual funds at the end of the day. What’s more, commissions vary widely, depending on negotiations with your broker or fund dealer.

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Second, the MER (Management Expense Ratio) is generally much lower on ETFs than on conventional mutual funds. That’s because most ETFs take a much simpler approach to investing. Instead of actively managing clients’ investments, ETF providers invest so as to mirror the holdings and performance of a particular stock-market index.

ETFs practice “passive” fund management, in contrast to the “active” management that conventional mutual funds provide at much higher costs. Traditional ETFs stick with this passive management—they follow the lead of the sponsor of the index (for example, Standard & Poors). 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 change. 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 you should stick with “traditional” ETFs. However, when an investment product faces booming demand as ETFs do today, investment companies try to expand sales by creating new versions of the underlying formula.

These new ETFs use a conventional stock-market index as a base, but add their own refinements. These refinements are tailored to current investor preferences or prejudices. That’s distinctly different from the traditional ETF, which simply aims to mimic an index. These newer, theme varieties may attract attention—and sales—but they frequently carry higher MERs.

In some cases, the new ETF may provide investment benefits but not consistently. In fact, it may hurt results, in the long run. The worst cases are bad enough to turn investor profits into losses. One sure result is that the higher MERs will cut into the value of your ETF portfolio every year.

Another drawback to the newer ETF is how much easier it is for investors to act on an urge to invest in a specific stock or stock group without doing any messy and time-consuming research. If you want to invest in oil stocks or gold stocks or Swedish stocks or wind power stocks, or any of hundreds of other stock groups, you can act on that urge. However, that may not win you the best results.

Below is a list of 6 things you should consider before buying an ETF investment:

  1. ETFs can be volatile, even with the diversification they offer.
  2. Know how broad the fund is, so you can determine its volatility. The broader the ETF, the less volatility it may have. A sector-based ETF like one that tracks resource stocks may be more volatile.
  3. Know the economic stability of countries when investing in international ETFs. It’s also good to mention that foreign leaders may not be your ally when it comes to passing legislation that can affect your investments
  4. Know the liquidity of ETFs you invest in.
  5. Determine if the ETFs you buy will include capital gains distributions.
  6. Consider buying ETFs in a lump sum rather than periodic small amounts to cut down on brokerage fees.

What year did you acquire your first ETF investment? Was it profitable? Share your experience with us in the comment section.



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