It has become a standard conversation, particularly when people bend my ear about investments: What exchange-traded fund (ETF) should I own? Which ETF funds are the best?
It’s a funny question, since the whole point of index funds and ETFs is to do away with the notion of “best” and get people to buy plain vanilla.
Now, naturally, nobody likes to buy anything “vanilla.” It’s a law in marketing that your brand has to be different, flavorful, exciting…not vanilla.
So let me tell you why you want “vanilla” investments. Because they work. And because you can get all the chocolate sauce and cherries you want on top by employing simple portfolio management strategies while using them.
So, which ETF funds should everyone own? Here are some ways to comparison shop:
1. Own ETFs that track well-known indexes
You know which ones. The Dow Jones Industrial Average, the S&P 500, the Nasdaq. A few great ETFs follow “total market” strategies that cover literally thousands of stocks. Same with bond funds. Read prospectuses. If you can’t find a good explanation of what the ETF tracks, stay away.
2. Use ETFs that are long only
No short ETFs, no “inverse” funds (it’s the same thing) and definitely no leveraged ETFs. These are a new wrinkle in the industry, as are alternative ETFs that promise active management on top of holding an index. The problem here is increased risk without an increased return.
3. Apply a simple “fee test” as a check
The cheapest ETFs are priced around the cost of index funds. Often, there is a zero on the right side of the decimal, meaning their cost is in the hundredths of 1 percent. The cheapest right now is at 0.04%, which is crazy cheap. Even if you pay 0.15%, that’s a bargain compared to the 1.27% or more some folks pay for active mutual funds.
4. Look underneath the hood
ETFs are funds. They have prospectuses. You should read them and understand how they invest. If the fund tracks an entire index at a low cost, that’s the one to buy. If it attempts to do so in a tricky way that’s not well explained, avoid it.
5. Commission-free is a good sign
Low fund fees are paramount, but most brokerages also offer a selection of ETFs at no trading cost. That’s often a good indicator that these are the funds that they expect most retail investors to use.
ETF funds are not hard to buy or own. Deployed in a thoughtful asset allocation plan, they can give your portfolio all the power it needs to drive your investing results to the level you expect at a minimum of risk.