How to Choose an ETF

Navigating through the growing ETFs maze.

With so many ETFs of all shapes and sizes now available on the market, finding the right one to invest in can sometimes be a difficult choice for investors.

Below are a few suggestions on what to look out for when choosing ETFs.

Align to allocation

First and foremost, finding the right ETF should depend on your own investment objectives, portfolio asset allocation plan and personal priorities.

For example, if you are just starting to invest and unsure where to start, perhaps a diversified ETF that provides exposure to a range of asset classes including equity, fixed income and cash is a good introductory step as it allows for broad diversification.

If the majority of your holdings are currently in shares, then perhaps investing in a fixed-income ETF will help diversify your equity market exposure.

Similarly, if you’re finding yourself favouring domestic investments but unsure how to invest directly in international shares, then an ETF tracking a global index might provide the missing link.

Know your provider

Apart from market forces, how well an ETF performs can also depend on how it is managed. Investing with a reputable fund manager with experience and a good track record of delivering index performance is important.

When selecting ETFs, dig a little deeper and find out what each provider’s investment philosophies are and what objectives they prioritise when offering products.

An ETF provider with a disciplined approach to portfolio management as well as the scale to have dedicated risk, research and investment teams is more likely to produce long-term returns.

Compare the costs

Costs are one of the more straightforward ways to compare ETFs and can be particularly important when you are selecting between sometimes similar products. Like we always say at Vanguard, while you can’t control the markets, you can control your investment costs.

ETF fees vary across the board depending on the provider, the market and sector, as well as the index being tracked.

ETFs generally come with an annual management fee and sometimes, an indirect cost. Fee details can generally be found in the ETF’s product disclosure statement (PDS) and fund fact sheets, where you’ll also find information on the index, distributions and associated risks.

Other costs to be aware of are brokerage fees (dependent on the platform through which you trade) and the bid/ask spread which is the difference between the ETF’s buy and sell price. The latter is determined by market liquidity and what’s going on in the market at any given time; the less investor demand, the wider the spread.

Don’t trade the trends

The hallmark of a sound ETF is that it delivers the returns of the underlying market or markets that the index is built to track.

Niche or thematic ETFs constructed around a specific subject matter may have periods of heightened popularity (think robotics, precious metals or cryptocurrency), but may not stand the test of time once the trend begins to fade or suffer dramatic bouts of volatility that will test your investment nerve.

As these ETFs are often narrow in focus, they lose out on the same diversification benefits inherent in broad-based ETFs. What’s more is that due to their new and largely untested nature, it’s difficult to evaluate liquidity and how accessible it is to trade during periods of volatility.

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General Advice Warning: This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.

Original Article: Vanguard (2024). How to choose an ETF.

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