When shopping for an exchange-traded fund (ETF), there are some things worth checking out. In a recent blog for Barron’s, Chris Dieterich offers a checklist:
Most investors should focus on the simplest ETFs. Big funds are usually the best option, but all are not necessarily created equal with respect to the mix of holdings.
Make sure you know your ET’Fs index. Market-cap weighted benchmarks (i.e. S&P 500) work well for most investors, but understand that this type weights the largest companies most heavily, making them the primary drivers of performance.
There’s been a huge push to sell investors “smart beta” ETFs (managed based on factors such as value, volatility, momentum, etc.). While not necessarily bad, these funds are not “magic bullets.”
In most cases, avoid niche funds. Heavy concentrations of single stocks can result in a top-heavy fund that counteracts the advantages of diversification.
Beware of “roll” costs. Many popular commodity ETFs are fighting against “structural quirks” that eat away at returns, such as the futures contracts behind commodity-based funds. In these cases, ETFs are forced to pay more when “rolling” into new futures contracts (longer-dated are more expensive than their shorter-dated counterparts).
ETF costs include more than expense ratios. Unlike in mutual funds, an ETF investor must trade themselves, so good trading “hygiene” should be observed. It’s important to check the bid-ask spread on a trade (difference between the price quoted for an immediate sale and that of an immediate purchase) because these costs add up.
Investors should pay attention to order types when buying and selling ETFs. Make limit orders the default—these set defined prices around them and give investors an added layer of control. Market orders, for example, see the best available current price and can leave investors vulnerable to sudden price swings.