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How to select ETFs?

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How to select ETFs?

How to select ETFs among the 5,000?

With more than 5,000 ETFs to choose from around the world, building a portfolio with ETFs requires the need to establish a framework for action that helps us in the task of how to select ETFs and what criteria must be taken into account to select the most suitable for the objective we seek.

How to select ETFs the 4 most important criteria?


In the ETF process, multiple aspects must be excluded. Here we include the 4 aspects that seem most decisive to us.

What exposure do you want?

ETFs, even within a certain asset class or market segment, can vary significantly. You need to be clear about the exposure you want, the index or indexes you want to track, and make sure the selected ETF is capturing that. If you have doubts you should look at the ETF file and make sure that it meets the requirements you are looking for and clearly identify that the benchmark used is the same index to which you want to be exposed.

What is the total cost?


In another post we have already addressed the issue of how to select ETFs. In this we do it in a more summarized way, introducing the concept of total cost, bringing together several aspects. The expenses associated with our investment process are always a very important and often little transparent aspect in traditional services. ETFs are characterized by having 95% lower costs than managed investment funds. We can have exposure to the S & P500 (the 500 most important companies in the American stock market) by 0.05%. But all the implicit costs must be taken into account, not only the TER of the chosen ETF, but we must also take into account the cost of buying and selling the ETF in the market desired since these are listed as a share. Therefore, the costs of the intermediary for the sale and custody of our securities will also be important. The brokerage cost will become less important if our portfolio is to undergo little change over time.

In the concept of total cost, it is sometimes customary to include the tracking error with respect to the index. The higher this is, the more it will cost us to follow the index. In other words, the real yield obtained will be lower not only due to the TER of the ETF but also due to the error in the index tracking giving a differential or additional cost. Additionally, it is also good to consider the average spread of purchase and sale. This will be a hidden cost that we will be bearing when entering or leaving our position.

What is volume?


Although normally a particular investor does not trade significant volumes, it is important to consider the volume of the ETF apart from the cost, when we ask ourselves how to select ETFs. The more volume, the more liquidity. ETFs with more liquidity tend to have lower average buy spreads and it will be easier to get in and out of our positions.

What type of replica does the ETF use?

We have already covered the 3 most important points in the selection process in the previous paragraphs. However, it is convenient to try to exclude synthetic replica ETFs from our selection when we ask ourselves how to select ETFs and therefore consider this fourth aspect. These tend to be cheaper, but this type of replica has additional risks or constraints that should be avoided as much as possible to simplify our selection. If you want to read more about this specific point click here.

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