The world of finance can be a tricky place to navigate, particularly for those who are just starting out in it. While it is hardly the most glamorous business sector out there, financial services remains an important segment of the global economy. As such, there are now a range of exchange-traded funds (ETFs) that have been created with the specific goal of making it easier for investors to access different financial markets.
These ETFs focus on various subsectors within the financial services industry and offer users a convenient way to gain exposure to them without having to invest in individual stocks. Given that this is still an area that can be quite complex for many people, here are 7 tips on how you can choose the right financial ETFs for your portfolio.
#1. Research the Different ETFs
One of the most important aspects of choosing the right financial ETFs is researching the different ETFs on offer. This can be challenging given the sheer number of ETFs out there, but it is an essential first step for any investor. In particular, you should look at the composition of the ETF, such as what assets it focuses on and how it is constructed. You should also pay attention to the fees involved in the ETF. These fees can have a major impact on your investment return over the long-term and should therefore not be ignored. You should also be aware of any other restrictions or risks that are involved in the ETF, particularly if you are planning on holding it for the long-term.
#2. Look for ETFs with Low Fees
As mentioned above, you should closely examine the fees associated with each ETF that you are considering. In particular, you should pay attention to the expense ratio, which is a measure of the ongoing management cost of the fund. For example, you should aim to avoid any ETFs that have an expense ratio above 0.5% as this will lower your investment returns over the long-term. Most ETFs charge their investors a management fee based on the amount of money being invested in the fund. This means that ETFs that charge lower fees may be a better choice for smaller portfolios than ETFs that charge higher fees. However, you should also keep in mind that some ETFs charge a fixed annual fee, which can be higher than an expense ratio based on the amount invested. This is particularly true for actively managed ETFs and the difference can be significant.
#3. Think About Risk and Return
Before choosing the right financial ETFs, you should think about the risk and return profile associated with each of them. You should consider how an ETF is likely to be impacted by external factors, such as the general economic environment, interest rates and exchange rates. You should also think about how an ETF’s risk and return relates to your broader portfolio. If you have a broadly diversified portfolio, then you may be able to afford more risk than someone who has a very concentrated portfolio.
Read Gold ETF: Pros and Cons of Investing in Gold.
#4. Check the Track Record
The next aspect of choosing the right financial ETFs is checking the track record. Specifically, you should look at the past performance of the ETF to see how it has performed in different economic environments. You should also examine how it has performed over longer time periods, such as over the past 10 or 20 years. While past performance is no guarantee of future results, it can be useful as a starting point when assessing different ETFs. It can also help you identify ETFs that have consistently outperformed their peers over a long period of time. You may want to give extra consideration to these ETFs, as they may be particularly well-positioned to benefit from future economic conditions.
#5. Be Aware of the Investment Limitations
Finally, you should be aware of any investment limitations associated with the ETFs that you are considering. For example, ETFs that invest in bonds may have specific limitations on the types of bonds that they can invest in. Depending on the ETFs that you select, you may need to be aware of any potential conflicts of interest that are presented by the fund manager. For example, if a fund manager works with multiple ETFs, it can be challenging for him or her to provide unbiased investment advice. When in doubt, you should examine the investment limitations set out in the fund’s prospectus, which is a document that outlines its rules and risks.
#6. Don’t Only Focus on the Big Brands
When choosing the right financial ETFs, you may be tempted to focus on the big brands that have been in the industry for many years. While it is certainly important to consider how long a particular fund has been around, you should also look beyond the brand name. This can be particularly important if you are trying to choose ETFs in a less established segment of the market. In these cases, you may be able to find ETFs that are managed by just as capable fund managers but that don’t have the same brand recognition.
#7. Take a Broader View When Selecting ETFs
As you are researching and evaluating different ETFs, you should also keep in mind the broader view of the industry. This can help you to avoid getting overly focused on specific subsectors of the market, which can sometimes lead to poor investment decisions. For example, if you are considering investing in ETFs that focus on the agriculture sector, you should also be aware of how they may be impacted by factors outside of that sector. This can help you to avoid investing in ETFs that may be at risk of falling out of favor due to factors that are largely outside of their control. In the same way, you should be aware of how your ETFs are likely to impact the wider financial services industry. This can help you to avoid falling into the trap of viewing your investment decisions in isolation.
Summing up
Choosing the right financial ETFs can be an important part of managing your investment portfolio. To do so successfully, you need to do more than just look at how much an ETF has risen in the past. In order to choose the right financial ETFs, you should first research the different ETFs on offer and examine their risk and return profile. You should then think about how each ETF is likely to be impacted by external factors and how it will impact the broader financial services industry.
