How to pick winning ETFs for better investment returns?
Imagine that instead of buying a lot of different stocks and getting yourself confused, you can buy just a single one that reflects the average gain of all the individual stocks.
And as it turns out, you can do that; using ETFs (exchange traded funds).
Now we should not confuse ETFs with Index Funds. Even though most ETFs track indexes, there are other types of it as well, which we will discuss below. But as Index Funds are a bit harder to trade and require a minimum investment amount to get started with, we turn our attention to ETFs. ETFs are a type of investment that are meant to track:
- An index that represents a portion of the financial market like S&P 500 Index that represents the 500 largest US companies
- A sector or industry in the economy that could be either local or more global like MSCI World Energy Index
- A commodity to track the investments in assets like gold, silver or oil which are attractive investment options for a lot of folks
But enough with ETF introduction (if you are interested in learning more about ETFs, read this link thoroughly with a full cup of coffee). In our short introduction, we understood that ETFs give us diversification and exposure to a wide range of different stocks and other investment assets, BUT
What are the criteria for choosing the right ETFs?
Which ETFs are looking good in 2021 with the impacts of both covid and economic recovery after vaccination rolls out?
Just remember that the ETF options which we will explore are by no means the investments you should make. Please do your own research as well to make sure you are placing your money in the right place. Also, as consistent with the theme of our blog, we tend to look for longer-term investments; so if your horizon is a bit short-term, you might not get a lot of value from this blog post.
Now, let's jump into it. First,
What makes an ETF attractive for investing?
Well, the easy answer would be past performance, right? But past performance is NEVER a good indicator for the future success of any investment asset. A smart investor knows that the past does not predict the future.
When evaluating an ETF, you might want to consider few or all the factors below which can have a better predictability for the investment success. Remember that the factors for predicting ETF success are not limited to this list:
Expense ratio: Even though predicting the future is out of our control, the costs we incur when making an investment is totally in our control. Investment costs compound as your portfolio grows over the years and shrink your overall return, so be mindful of the Expense ratio percentage when buying ETFs. As a general rule, avoid ETFs with an Expense ration of more than 0.5% - 1%. I personally have few ETFs with an expense ratio below 0.1% (which are relatively passive) and few more ETFs with an expense ratio of between 0.1% and 0.4%.
Fund composition: As an investor you need to be aware of what your investment funds consist of. In the case of ETFs, it is important to know what type of asset classes does the fund hold; Is it mainly equity, or does it hold bond and other fixed income assets as well? These factors are important in terms of expected return, tax benefits, etc.
Also, we need to know how many companies or assets are listed in a fund; one asset could consist of 30-40 companies while another fund can include 2000 companies. Both options could work, but they might bring different levels of output.
For an investor that plans to buy a single ETF, buying a more diversified ETF that represents the general market might be more ideal; however, someone who plans to buy several ETFs need to be exposed to different groups of assets that differ in their scope and do not overlap a lot.
Asset type/industry: As we discussed, ETFs can track many different types of investment assets such as index, currency, sector, industry, region. Do your research and find valuable areas or sectors that are worth investing into them for the long run. You should never buy an ETF unless you know something about the sector its assets are invested in.
For example, personally I love technology companies and would rather invest the majority of my money in technology based ETFs. Also, I try to keep up with the overall economy situation and to protect my investments from the effects of inflation or recession by investing the appropriate ETFs for each economic scenario.
Finally, there are some industries that I do not value personally; either because of their malpractices or general economic output. An example of it would be "sport betting or any other gambling" companies, which personally I do not value and therefore I would not invest in, even if they yield a very high profit in the long run. You need to know your values in life as well to become a better value investor.