ETF 103: Does Your ETF Have High Standards?
February 18, 2020
Would you ever purchase a car, blindly—before looking into factors such as crash rating, gas mileage and how the car is priced compared to other manufacturers? Of course not—similarly it is important to pop the hood of your ETFs and evaluate them, before purchasing.
However, knowing how to evaluate an ETF is a skill
Investors can fine tune their skill sets by focusing on three main areas: ETF construction, performance and total costs
One of the first steps in evaluating an ETF is understanding how it’s constructed—by looking at the underlying holdings, investors can develop a realistic picture of its overall exposure.
For example, if an investor is seeking targeted exposure to a specific sector, looking into whether an ETF holds large multinational conglomerates may factor into whether or not that particular ETF is the best fit.
Investors should also examine the security inclusion rules of the underlying index, meaning—the rules that govern what securities the fund should hold, and furthermore, determines how the fund allocates to those selected securities.
Tacking a fund’s performance can be done through multiple lenses- giving investors insight into how an ETF performs on its own and in comparison to its peers or underlying index.
The three main lenses of performance are:
1.Individual fund performance over time -- giving insights into how market conditions affect it
2. Performance versus peers -- displaying how differences in fund make-up affect reactions to changes in the market
3.Performance versus the underlying index -- evaluating the total return difference to measure how closely an ETF performed relative to its index
“Low cost” is a common attribute associated with ETFs however, there are still expenses associated with investing in ETFs and it’s important to understand them
1.Fund expenses or, expense ratios -- explicit costs of ETFs. While low fund expenses can seem like a positive, be aware of the kind of performance or exposure that accompanies them.
2.Trading costs -- These can include commissions, liquidity, and bid-ask spreads which affect the ease of cost-effective trading.
3. Portfolio turnover and rebalancing -- ETFs periodically rebalance their holdings to remain in line with their respective indexes and hold securities in the correct proportions. The more frequent they rebalance, the higher the portfolio turnover -- and the greater the chance of elevated trading costs—providing a system of checks and balances
4.Capital gains -- some types of ETFs may still generate tax liabilities
Knowing how to evaluate an ETF is a critical skill for successful investors. By taking the time to pop the hood of an ETF- understanding its exposure, performance and costs, you should be well-equipped to choose the right ETF for your needs.
To learn more, visit www.vaneck.com
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Diversification does not assure profit nor protect against loss.
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