Choosing Successful ETFs: Factors and Risks
February 24, 2018
Since the launch of Standard & Poor’s Depositary Receipts, ETFs have changed and progressed in the stock market. Now, one ETF follows what S&P 500 does. That has led it to become a favorite among investors. Furthermore, it allowed the creation of other U.S. indexes, like Dow Jones and Nasdaq 100.
However, picking the right ETFs can be tricky due to the fact that they are not all the same. Some of them can even get liquidated, usually because the investors do not care for them that much. Finding the best ETFs is vital if you want to see your business thrive. Keep reading to find out how to choose the right ones.
The market currently offers more than 1,900 ETFs (as of October 2016). Together, they are all worth more than $2 trillion. In addition to that, there are many different types you can choose from: commodities, bonds, indexes, and sub-indexes. You can even select an ETF which has its basis in investment and market capitalization.
Battles of the ETFs
ETF issuers are highly competitive, and they sometimes focus on ETFs that are very specific or based on a trend. One of them is Loncar Cancer Immunotherapy ETF (CNCR) which focuses on 31 stocks.
When it comes to trends, they usually focus on social interests. For example, Robotics & Artificial Intelligence Thematic ETF, and Obesity ETF (SLIM).
How to choose the right one
Choices are abundant, and you have to do your research and pick the best one. Here are some factors you should take into consideration:
- It should have a threshold of $10 million or more. Otherwise, it is not an ETF that would attract an investor’s attention. That leads to wide spreads and even poor liquidity.
- When you are research ETFs, make sure that they trade in enough volume daily. The higher it is, the better the liquidity and the bid-ask spread of the ETF.
- The underlying index. If you want your ETFs to be successful, choose the ones that have widely followed indexes. Otherwise, you might be limited to a geographic focus or an obscure industry.
- Tracking Errors. It might be obvious but bear in mind that some ETFs have poor tracking indexes. Therefore, choose the ones that have the minimal level of mistakes.
- Market Standing. You should try to avoid ETFs that are only copying someone else’s original idea. The first-movers gather all the assets, so it is counterproductive to pick ETFs that are too similar to the others.
Closing an ETF
Before the liquidation of an ETF, the issues notifies all investors about it. When that happens, investors should think fast and come up with a plan that would protect their investments. Here are some of the solutions:
- Sell it before it stops trading. If there is a risk that there might be a severe decline in the ETF towards the date when it stops trading, this is a safe choice. However, bear in mind that there will be a wide bid-ask spread because the ETF is closing.
- Keep it until it stops trading. If there is no risk whatsoever, then you can hold on to your ETF until the “stop trading date.” Still, the ETF should be from a sector where the decline risks are minimal. That also means that there will be a tighter bid-ask spread towards the end.
Nevertheless, you cannot escape the taxes that follow the liquidation of an ETF. If an investor kept them in a taxable account, he would have to pay for any capital gains.
Factors like the level of assets, and how much ETF trades during the day, are vital when choosing the best one. Furthermore, you must not forget to check the underlying index of each of the ETF you are considering.
If an ETF comes to a close, then the investor has to plan a course of action and protect his investments. He can do that by selling before the deadline or waiting until the liquidation.