Finding the right ETFs for your portfolio

Some people are just too busy to manage their investments. They lack the time, desire or expertise to monitor stocks, bonds and other securities daily. These investors often turn to exchange-traded funds (ETFs).

Low costs, high liquidity and ease of use make ETF investing attractive for average investors who do not want to be bothered with managing their portfolios. ETFs have emerged over the past few decades as one of the quickest growing investment vehicles available today because they offer instant diversification at a meagre cost, making them perfect for investors looking for simplicity.

What is an ETF?

An Exchange Traded Fund is exactly what it sounds like – security that tracks an Index or Sector that can be bought and sold like a stock on the Exchange.

ETFs are available for almost every Index or Sector that you can imagine, and unlike Mutual Funds, which only come in one flavour (Open-Ended), ETFs come in hundreds of flavours. It gives individual investors many more options to tailor their investment portfolios to meet their specific needs without incurring the high management fees of traditional mutual funds.

What is essential to know about ETFs?

ETFs are not necessarily better than mutual funds. Both have advantages and disadvantages.

The main difference between an ETF and a mutual fund is how they trade during the day. A mutual fund can be purchased once per business day after the exchanges open, but an ETF trades throughout each trading day like any other stock.

The other advantage to ETFs is how they are taxed. Mutual funds pass capital gains directly through to their investors each year. Conversely, investors who purchase and sell ETF shares typically incur a taxable event only when the ETF share price has risen above the original purchase price of the share or if it is sold for a loss.

On the negative side, however, mutual funds typically have lower expense ratios than ETFs because traditional mutual funds continuously offer new shares to be purchased, usually at NAV (Net Asset Value). At the same time, ETF shareholders do not receive any new cash unless they choose to reinvest their dividends or capital gains distributions. It may be considered an advantage because individual investors control when their investments are liquidated into cash. In contrast, the money is automatically reinvested into the fund with most ETFs.

Which ETFs are best suited for beginners?

Beginners are generally better off using Index ETFs to build their portfolios because they are easy to understand and trade. For example, if you wanted to replicate the S& P 500 Index, an investor could purchase shares of both SPY ( SPDR S& P 500 ETF) and IVV ( iShares Core S&p 500 ETF). Nowadays, even some newer mutual funds have similar replication strategies, so choosing one over another becomes a matter of cost preferences.

For those beginning investors looking for more diverse investment opportunities that can be tailored to their individual preferences or risk tolerances, Sector-based ETFs may be more appealing. Many Sector ETFs are available to the public for investment at a low cost. One recent example that has gained much attention is GDXJ ( Market Vectors Junior Gold Miners ETF), which focuses on small-cap mining companies involved in gold production.

Although this investing requires more research, it can provide higher returns over time. Junior mining companies typically have much less market capitalization than their larger counterparts, so they are more prone to large price swings when economic conditions change or geopolitical events occur.

Typically, Sector ETFs are best suited for long-term investors who want to take advantage of specific opportunities within the markets where individual company performance may deviate from broad market indexes. Although there are some risks inherent with investing in these types of funds, the ETFs themselves trade like stocks, so there should be less concern over liquidity issues since all investors will have equal access to buy and sell shares.

Bottom line

ETFs offer many ways that individual investors can customise their investment portfolios, whether they are looking for broad market exposure or increased diversity of Sector investments. Remember that trading ETFs is not much different from trading any common stock. Although you should generally only invest money in an ETF if you plan on holding it long-term, it is essential to pay close attention to the day-to-day fluctuations of the underlying share price and other relevant information about the company itself so you can make quick decisions when necessary.