Investing in exchange-traded funds (ETFs) has become increasingly popular in recent years, and for a good reason. ETFs offer a convenient and cost-effective way to invest in diverse assets, from stocks and bonds to real estate and commodities. However, with thousands of ETFs to choose from, it can be overwhelming to figure out which is the best fit for your investment goals and risk tolerance. In this blog post, we’ll break down the key factors to consider when choosing an ETF and provide tips on picking the right one for you.
What is an ETF?
Before diving into the details of picking the right ETF, let’s first define an ETF. An ETF is a type of investment fund that tracks the performance of a specific market index, such as the S&P 500 or the NASDAQ. ETFs can be bought and sold just like stocks on a stock exchange, and they provide investors with a way to gain exposure to a broad range of assets with a single investment.
One of the biggest advantages of ETFs is their diversification. By investing in a basket of assets rather than just one stock or bond, ETFs can help reduce the risk of your portfolio. ETFs also offer a convenient and cost-effective way to gain exposure to a specific market or sector, such as technology or emerging markets.
FACTORS TO CONSIDER WHEN CHOOSING AN ETF
Asset Class
The first factor to consider when choosing an ETF is the asset class. ETFs come in various asset classes, including stocks, bonds, real estate, and commodities. Every asset class has its own set of risks and returns, so it’s important to understand the peculiarities of each and how they align with your investment goals and risk tolerance.
For example, a stock ETF may be a good fit for you if you’re looking for long-term growth and are comfortable with higher risk. Alternatively, a bond ETF may be a better option if you’re looking for income and stability.
Market or Sector
Another factor to consider when choosing an ETF is the market or sector it tracks. ETFs can track various markets and sectors, such as the S&P 500, the NASDAQ, or the Dow Jones Industrial Average. They can also focus on specific sectors, such as technology, healthcare, or energy.
It’s important to understand the characteristics of the market or sector the ETF tracks and how it aligns with your investment goals. For example, suppose you’re bullish on the technology sector. In that case, an ETF that tracks technology companies may be a good fit for you. However, it’s also important to consider the level of risk and volatility associated with the market or sector. Some sectors, such as technology or biotechnology, may be more volatile than others, so it’s important to keep that in mind when making your investment decision.
Expense Ratio
The expense ratio is another important factor to consider when choosing an ETF. The expense ratio is the annual fee that the ETF charges to cover its operating expenses. It’s important to pay attention to the expense ratio, as it can significantly impact your overall returns. Generally, you want to look for ETFs with low expense ratios as they will eat into your returns less.
Liquidity
Liquidity is another important factor to consider when choosing an ETF. Liquidity refers to how easily you can buy or sell shares of the ETF. ETFs with higher liquidity will generally have tighter bid-ask spreads, which means that the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept is smaller. ETFs with lower liquidity may have wider bid-ask spreads, meaning that the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept is larger.
Performance
Finally, it’s important to consider the performance of the ETF when making your investment decision. Performance refers to how well the ETF has performed in the past. While past performance does not indicate future results, it can give you an idea of how the ETF has performed in different market conditions.
TIPS FOR PICKING THE RIGHT ETF
Understand Your Investment Goals
The first step in picking the right ETF is understanding your investment goals. Are you looking for long-term growth, income, or stability? Are you comfortable with higher risk, or do you prefer lower-risk investments? Understanding your investment goals will help you narrow down the ETFs that are the best fit for you.
Diversify Your Portfolio
Another important tip for picking the right ETF is to diversify your portfolio. Diversification implies spreading your investments across different types of assets and sectors. By diversifying your portfolio, you can reduce the overall risk of your investments and increase your chances of achieving your investment goals.
One way to diversify your portfolio is to invest in various ETFs that track different markets and sectors. For example, you could invest in a stock ETF that tracks the S&P 500, a bond ETF that tracks the Barclays Aggregate Bond Index, and a real estate ETF that tracks the MSCI US REIT Index.
Pay Attention to the Expense Ratio
As mentioned earlier, the expense ratio is an important factor to consider when choosing an ETF. It’s important to pay attention to the expense ratio, as it can significantly impact your overall returns. Generally, you want to look for ETFs with low expense ratios as they will eat into your returns less.
Consider the Liquidity of the ETF
Another important factor to consider when choosing an ETF is liquidity. ETFs with higher liquidity will generally have tighter bid-ask spreads, which means that the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept is smaller. ETFs with lower liquidity may have wider bid-ask spreads, which means that the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept is larger.
Research the ETF’s Performance
Finally, it’s important to research the ETF’s performance before making your investment decision. You can research the ETF’s performance by looking at its historical returns and comparing it to other ETFs in the same market or sector. It’s also important to pay attention to the ETF’s performance in different market conditions, as it can give you an idea of how the ETF will likely perform in the future.
Final Takeaways & Examples
In conclusion, ETFs are a great way to invest in diverse assets. Still, with thousands of ETFs to choose from, it can
be overwhelming to figure out which is the best fit for your investment goals and risk tolerance. Considering factors such as asset class, market or sector, expense ratio, liquidity, and performance, you can narrow your options and make a more informed investment decision. Additionally, by understanding your investment goals, diversifying your portfolio, and researching the ETF’s performance, you can increase your chances of achieving your investment goals. Before making investment decisions, consult a financial advisor, monitor the ETF’s performance, and re-evaluate your investment periodically.
Here is a short list of ETFs in no specific order of preference that you may wish to evaluate based upon the criteria listed above, with the caveat that, as investors, you should always conduct your own research and/ or consult a financial advisor before making any investment decisions.
- BMO S&P/TSX Capped Composite Index ETF (ZCN) – tracks the performance of the S&P/TSX Capped Composite Index, which is a market capitalization-weighted index designed to measure the performance of the large and mid-cap segments of the Canadian equity market.
- iShares S&P/TSX 60 Index ETF (XIU) – tracks the performance of the S&P/TSX 60 Index, which is a market capitalization-weighted index designed to measure the performance of the large-cap segment of the Canadian equity market.
- BMO MSCI EAFE Index ETF (ZEA) – tracks the performance of the MSCI EAFE Index, which is a market capitalization-weighted index designed to measure the performance of the developed markets in Europe, Australasia, and the Far East.
- BMO S&P/TSX Global Gold Index ETF (ZGD) – tracks the performance of the S&P/TSX Global Gold Index, which is a market capitalization-weighted index designed to measure the performance of publicly traded companies involved in the gold industry.
- iShares S&P/TSX Capped Energy Index ETF (XEG) – tracks the performance of the S&P/TSX Capped Energy Index, which is a market capitalization-weighted index designed to measure the performance of publicly traded companies involved in the energy sector.
- BMO S&P/TSX Capped Financials Index ETF (ZF) – tracks the performance of the S&P/TSX Capped Financials Index, which is a market capitalization-weighted index designed to measure the performance of publicly traded companies in the financial sector such as banks and insurance companies.
- iShares S&P/TSX Capped Materials Index ETF (XMA) – tracks the performance of the S&P/TSX Capped Materials Index, which is a market capitalization-weighted index designed to measure the performance of publicly traded companies involved in the materials sector such as mining and metal companies.
- BMO S&P/TSX Capped REIT Index ETF (ZRE) – tracks the performance of the S&P/TSX Capped REIT Index, which is a market capitalization-weighted index designed to measure the performance of publicly traded Real Estate Investment Trusts (REITs) in Canada.
- iShares S&P/TSX Capped Consumer Discretionary Index ETF (XCD) – tracks the performance of the S&P/TSX Capped Consumer Discretionary Index, which is a market capitalization-weighted index designed to measure the performance of publicly traded companies in the consumer discretionary sector such as retail, media and entertainment companies
- BMO S&P/TSX Capped Information Technology Index ETF (ZTK) – tracks the performance of the S&P/TSX Capped Information Technology Index, which is a market capitalization-weighted index designed to measure the performance of publicly traded companies in the information technology sector such as software, hardware and internet companies.
