When you first start investing in ETFs, the amount of choice can be overwhelming. We have over 500 ETFs on our platform, for example, so knowing which ones to choose can be difficult. As the industry continues to grow, this is only going to become a bigger problem.
If you want to invest in an ETF that tracks the S&P 500, for instance, you’ll have a number of slightly different options to choose from. There are also a plethora of more niche ETFs that track specific industries or particular trends.
So, what should investors be looking at when deciding which ETFs they want in their portfolios?
The fund’s costs
One of the key advantages to ETFs over other investment vehicles is their affordability. There are, however, some costs to consider when you’re building your portfolio. Here are some costs to look out for:
- Bid-ask spread. This is the difference between the market value of the ETF and the amount you’ll actually pay for it. This cost becomes less relevant the longer you intend to hold the ETF for.
- Management fees. In some cases, your broker may charge you commission for each trade or an ongoing management fee. Our DIY portfolios are subject to neither.
It’s important to calculate the actual cost of holding an ETF when considering it for your portfolio.
The fund’s tracking difference
Almost all ETFs are built to track a particular index and, in theory, the perfect fund would have exactly the same performance. In practice, this is difficult. Indexes are free from the drag factors that can affect ETF performance – transaction charges, taxes, regulatory fees, etc.
The difference between the performance of the index and the performance of the ETF is called the tracking difference. The best ETFs will keep this to a minimum. A lot of people will focus more on the total expense ratio than the tracking difference, but both are important considerations.
The size of the fund
Another consideration is the size of the fund itself. To be considered a worthwhile investment, ETFs need to be large enough to maintain investor interest and avoid closing (a rare occurrence).
The minimum threshold for ETF size depends on who you ask, but anywhere above the £10 million mark is considered safe. Larger ETFs can also benefit from reduced bid-ask spreads. This ties into choosing a reputable provider – you want one with the reputation and track record to feel secure in your investments.
The ETF’s trading activity
You’ll want to check that your ETF trades regularly enough on a daily basis. There is slightly more to it, but the trading volume is a pretty good indicator of how liquid a fund is. More trading can also mean tighter bid-ask spreads.
Trading activity can vary wildly between ETFs, too – some ETFs will barely trade, while some of the larger ETFs can run up millions of trades daily.
Summary
In short, selecting ETFs will mean balancing these considerations. The best place to start, we think, is the platform you invest on. At InvestEngine, for example, you’ll find that fees are barely a consideration.
We also hand-pick the ETFs that make up our range, so you can feel confident that you’re investing in best-in-class funds. For more information on ETFs and how they compare to other similar investment vehicles, check out our help centre.