Five Tips on Choosing ETFs

It's a fact: not all ETFs are a perfect fit for all investors.

Different ETFs serve different purposes. It depends on your risk tolerance, time horizon, investing style and the overall makeup of your portfolio.

For example, leveraged ETFs are great if you’re looking to hedge a position you hold to avoid having to sell it; they’re not great at all if you’re looking for something you can buy and sit on for a few years. Oil is a good investment if you want to capture the gains the commodity has been making in recent months, but it’s not ideal if you’re looking for something with low volatility.

Here are some things to look at when making that all-important decision:

• Broad vs. Narrow. Broadly diversified ETFs are a much better bet than an individual stock. But there are also broad and narrow ETFs – the narrow you get, the more sensitive to market movements your ETF may be. If you want to diversify a little more and keep the risk lower, consider broad funds.
• Annual fees. While expense ratios are low for most ETFs, don’t make the assumption that they’re all dirt cheap. Some of the specialized ETFs carry high fees. Be sure to check and compare before buying to see that you’re not paying more than you had intended.
• Know what you own. ETFs that are invested within an industry or a niche market generally carry more risk than a broad fund. It is up to the investor to do some homework and know what they are putting their money toward and what the risks are.
• How does it work? Some ETFs own stocks of a certain market value or size. Others even use complex bets that the stock market will fall. Buying these highly concentrated ETFs can often be very risky – do a gut check and be sure you understand the risks and construction and are comfortable, as well.
• Liquidity. A general rule is that the larger the assets and the higher the trading volume, the better the liquidity of your ETF.