The Six Questions Investors Should Ask Before Buying any ETF

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Posted: Nov 04, 2015 12:01 AM
The Six Questions Investors Should Ask Before Buying any ETF

I am often asked by readers, radio show listeners and clients about all things exchange-traded funds (ETFs). Why I like them so much, why they are better than mutual funds, why I prefer them to individual stocks, etc.

Today, I am going to provide a few questions for you, questions you should ask yourself before you buy any ETF.

Here is my list of the six key questions you must ask before you commit your investment capital to an exchange-traded fund.

1) Why am I buying? Do you need to generate growth from your assets, or is income more what you are looking for? Are you buying this ETF for a long-term hold, or do you plan on trading the fund? The first question of why you are buying is all about you and your goals, so the more defined your objectives are, the better your outcome is likely to be.

2) What asset class am I buying? Is this ETF an equity (stock) fund, or is it a bond fund? Is it pegged to a specific market sector, or is it an inverse fund? Knowing what you are buying is critical, so make sure you are fully aware of what’s in that ETF.

3) What index is my ETF following? Is your ETF exposed to the S&P 500? Is it pegged to the Dow? Or, is it pegged to the NASDAQ 100? All funds of this sort are broad-based equity funds, but they are not created equal in terms of composition and diversification. Knowing how diversified you are in a fund is important, and you know that by looking at the index the ETF follows.

4) What’s the cost? How much is that ETF going to cost you? What is its “expense ratio?” If you don’t know how much you’re paying for something, you can’t make a good decision about value.

5) What’s the asset size and volume of this ETF? Are you buying an ETF with a lot of liquidity and a lot of trading volume? Or, are you looking at an ETF with minimal assets under management and one that trades at low volumes? The answer here can make a difference when it comes to efficient trade execution and fund pricing, so be aware of the size of the ETFs you want to buy.

6) What’s my exit point? Do you know when you’re going to sell this ETF? How much downside can you handle? When will you take your winnings off the table? Only you can answer these questions based on your personal investing situation, but answer them you must if you want to be an efficient, and successful, ETF investor.

Finally, subscribers to my Successful ETF Investing newsletter recently received the first new domestic equity buy signal in some time. If you want to find out what we’re buying, then I invite you to click on the link above and check out the newsletter.