Deciding if an ETF is for you should not be a chore. This is why Investing Guides has written the below how to dissect an ETF guide. Simply follow these steps and you will have a new routine in no time!
Time needed: 15 minutes.
How to dissect an ETF in 10 easy steps
- Underlying investing products
The ETF must be investing in an underlying product such as stocks, bonds or commodities and more. Knowing the product means knowing how it does, or does not fit in your strategy.
- Cost clarity
Find the expense ratio, or ongoing cost figure (OCF). This cost is a payment to the asset manager at the end of the year. A low expense ratio is therefore good, as it means you keep more profits for yourself.
- Level of diversification
An ETF is generally preferred over individual stocks as it reduces risk and spreads your investment. The lower the concentration of top 10 instruments within an ETF is, the broader its funds are invested. Hence, the safer to invest in.
- Follow the index following
Read an ETFs description to find what index it follows and how. For example, if an ETF states it 'Seeks to track the performance of the CRSP US Total Market Index.', then it aims to concentrate your investment on the US market.
After identifying the index, it's now important to compare the performance of that index with the ETF. The closer this figure hits its counterpart, the better the investment.
- Assess the type
ETFs effectively have 2 types that cater to different strategies. Either an ETF is of distributing nature, in which case investors earn all dividends and interests on a period basis. Or, the ETF is of the accumulating type, where all earnings and reinvested into the ETF resulting in a compounding effect over time.
Look into the ETF historical performance as well as overall age. A 'young' ETF will most likely need more attention than an established one. If you are unsure of an ETF you found, simply continue searching and odds are you will find a different one tracking the same index.
- Financial 'size'
AuM, assets under management. A term that describes the 'size' of an ETF in this case. More AuM means a lower chance of the fund/company becoming insolvent.
- Know about leverage (& avoid it)
Leverage is a tool used by advanced investors and/or traders who know how it can be to their benefit. In ETFs, leverage can mean a market move is doubled or tripled in the ETF. This can leave you with a 60% loss (leverage X3) on your ETF if the market had a dip of 20%.
- Trading volume
Popularity and liquidity can both make or break an ETF. If many people buy and sell the instrument, it's considered more trustworthy. If the ETF holds stocks or bonds from a company that has issued many, it becomes easier and faster to buy or sell due to a higher supply.
- Bonus: KID & ESG
Each ETF, by law, needs to have a Key Information Document (KID). Although not the most engaging documents, they hold all major facts of the ETF. Moreover, on most EFT provider website's, you can find assessments on ESG.
Before you continue reading, make sure you know what an ETF is. You can read up on ETFs here. Should these steps have been helpful, then you can continue your journey on investing doubt here, or start investing in 7 steps here.
The work in choosing an ETF
Let's be honest, no one is thrilled to go through lists of documents and online PDFs in order to remember 2% of the information and hope they made the right choice.
When choosing an ETF, you want to be confident you chose it for the right reasons befitting your personal strategy. This does not have to take hours, not even 15 minutes!
Dissect an ETF instead
To dissect an ETF is to work targeted and only retrieve the information you truly need. The 10 steps in this guide are the key metrics after which you can make an informed decision about any ETF you are considering adding to your investment portfolio.