Which ETF’s Should You Be Trading?
The ETF industry is HUGE.
According to the Investment Company Institute, as of February 2017, we have 1,736 ETF's to choose from, with total assets of $2.7 trillion.
There's an ETF for everything.
Yes, we all know about SPY and QQQ and IWM, but did you know that there's an ETF for lithium?
That's right, you can ride the lithium market with the Global X Lithium (LIT) fund.
Into livestock?
Then check out the iPath Dow Jones-UBS Livestock Subindex Total Return (COW). (h/t to RothIRA.com)
Heck, there's even an ETF that invest in ETF companies… albeit not very well.
To help you make sense of the endless array of ETF's available to you, we're going to give you 5 basic ground rules to keep you away from the worst of the ETF lot.
1) If It's New, Tiny, or Illiquid, Stay Away
New ETF's tend to be expensive and illiquid, with plenty of alternatives that are already on the market.
Plus, a hot new fund may not actually ever garner enough assets to stay in business.
So why bother with them?
According to ETF.com, once a fund surpasses $50 million in assets, it's far likely to close, so that's a decent benchmark to keep in mind.
However, we'd suggest upping your minimum requirement to $250 million to reduce the likelihood of a fund closure during times of extreme market stress.
And if you're an active trader, look for funds that trade over 1 million shares per day.
This will ensure you can get in and out of them without too much trouble.
2) Forget Those Highly Specialized Sector Funds
As with many new ETF's, highly specialized sector funds are usually not worth trading.
Specialty funds are typically more expensive and less liquid than generalized funds with similar performance characteristics
For example, the Bioshares Biotechnology Clinical Trials Fund (BBC) sounds exciting, but it trades less than 13,000 shares a day. It also has an expense ratio of 0.85%.
The iShares Nasdaq Biotechnology ETF (IBB) trades over 1 million shares per day with an expense ratio of 0.47%.
Here, you can see a chart comparing IBB (bars) to BBC (purple line):
They look pretty much the same, though BBC has been more volatile and a weaker performer over this 2-year time frame.
3) Know What You Own
Before trading an ETF, you should actually make sure it fits your trading and investment objectives.
Always look at a prospective fund's underlying holdings, because you can't always rely on a fund's name to determine what it owns.
For example, the SPDR Homebuilders ETF (XHB) is more of a retail/building supply ETF than a homebuilders ETF.
Only 1 of its top 10 holdings is a homebuilder, and the biggest position is Williams-Sonoma (WSM)!
And if you're playing with anything fancy like leveraged ETF's or VIX-derived products like VXX and TVIX, run, don't walk, to the prospectus.
Quite often, these complex products have significant tracking errors and other risks of which you should be aware.
4) Check Your Free Options
Many large brokerage firms allow you to trade certain ETF's for free.
Every dollar you save on commissions is another dollar that stays in your pocket, so why not look into your free options?
For example, Fidelity offers commission-free trading of the popular iShares ETF's.
TD Ameritrade also offers free trading of select ETF's from iShares and Vanguard.
However, there are two caveats to keep in mind: there are usually some restrictions with free ETF trading, like a minimum 30-day holding period.
And secondly, some ETF's offered in commission-free trading programs aren't exactly top-shelf offerings. Occasionally, you'll come across a fund that has very little liquidity and a high expense ratio, which you'll want to avoid.
5) Stick With the Establishment
Most of the time, it makes sense to stick with the industry giants like Vanguard, iShares, State Street SPDR, and PowerShares.
In all likelihood, these companies will stay in business and remain very profitable for a very long time.
And because of rampant competition, fees just keep going lower and lower.
Plus, funds from major ETF companies, allowing you to get in and out of the market at will.
It's just one of those cases where bigger is almost always better.