Choosing the Best ETFs

Part of the Exchange-Traded Funds For Dummies Cheat Sheet

With about 1,300 exchange-traded funds available, where do you start to shop? The answer depends on your objective. If you are looking to round out an existing portfolio of stocks or mutual funds, your ETFs should complement your existing investments. Your goal is always to have a well-diversified collection of investments. If you are starting to build a portfolio, you want to make sure to include stocks and bonds and to diversify within those two broad asset classes. There is not much in the world of stocks, bonds, and commodities that can’t be satisfied with ETFs. Keep the following guidelines in mind as you make selections:

  • Mix and match your holdings appropriately.

    You not only want a well-diversified portfolio, but you also want one that includes various asset classes that tend to go up and down in value at different times. There’s no point to holding four different ETFs that all invest in large cap stocks. Hold a large cap ETF and a small cap, a U.S. stock ETF and an international stock ETF.

  • Go for lowest cost.

    As with any other investment vehicle, be careful of paying more than you need to. Although most ETFs are very economical, some are more economical than others. You may not always want to pick the cheapest, but certainly aim in that direction.

  • Don’t sweat the small stuff.

    Two ETFs that track similar indexes (such as, say, large value stocks) are not going to be all that different from one another. Spend some time researching your options, but don’t agonize over your selection. Much more important — perhaps worth a little agony — is choosing ETFs that track dissimilar indexes so your eggs are in different baskets.

  • Go passive.

    A handful of ETFs promise “active management.” Know that active management has an awfully spotty track record. The bulk, if not all, of your ETF portfolio should be in passively managed (indexed) ETFs.

  • Look for breadth.

    Examine the holdings of the ETF. As a rule, no one security (such as, for example, Microsoft or General Electric stock) should represent more than 10 percent of the ETF’s total assets.

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