Investing involves making choices with your money, and it can be confusing if you don’t fully understand all the options. One model is the exchange-traded fund, or ETF. This works a bit differently than a mutual fund or a stock and can bring diversity into your portfolio. Here’s what a ETF is and how to choose a good one.
An ETF owns shares in individual companies, usually within a certain category or market segment. The largest ETF is the SPDR S&P 500 ETF; this invests in the Standard & Poor’s 500 index, or the 500 largest companies on U.S. market exchanges. Other ETFs are very niche. For example, the Cancer Immunotherapy ETF invests in companies that use immunotherapy to fight cancer.
An ETF is not a mutual fund. (Learn more about mutual funds here.)When you invest in an ETF, you are not a shareholder in the companies in the ETF. You can benefit indirectly from the companies’ success through investment in the ETF.
If you are a new investor, always talk to a qualified financial professional before investing any money. But here are some common factors that are important to consider before committing to an ETF.
Investopedia recommends a minimum asset level of $10 million. This is an indication that other investors are interested in the fund.
The ETF’s trading volume can give you an indication of liquidity. In general, greater trading volume means greater liquidity, an important consideration if you are looking ahead to an exit out of the fund.
Like all investments, you may want to diversify in order to protect against losses. The S&P 500 ETF is by its nature very diverse; the Cancer Immunotherapy ETF, by its nature, is not necessarily diverse. Consult with a financial advisor about what level of diversity is best for you considering your personal risk profile.
If an ETF is first to jump into a particular market segment, it may get the most valuable assets. You may have to really understand a particular market in order to choose the best ETF in which to place your money, and more importantly, how to differentiate the originals from the imitators.
ETFs are an exciting and potentially beneficial investment, but it’s important to know how they are different from other financial vehicles. Talk to the experts, read up on different funds, and fork over your cash only when you feel comfortable with the risk. On the other hand, if you’d prefer assistance with your investments, consider whether the aid of a robo advisor is right for you. The top online investment sites are a great place to start.
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