I’m quite new to the ETFs world, but today I want to share with you the 8 main criteria that I believe should be taken into consideration in the choice of the right ETF.
What is an ETF?
To make it simple, an ETF (Exchange-Traded Fund) is a fund that tracks an index. Examples of indices are the FTSE 100 or the S&P 500.
Substantially investing in an ETF the investor invests in a large number of shares thus combining the benefits deriving from owning shares with the low costs insured by the ETFs.
This is why more and more people decide to invest through this incredible financial instrument. And this is why I decided to start to analyze this world in order to invest a big percentage of my Investment Portfolio on it.
How to Find the Right ETF
There are more than 5000 ETFs trading globally. This is a huge number!
My ultimate goal is to invest on 3/4 ETFs. You can easily understand that in order to achieve this goal in an effective way I need to make a very hard selection.
This is why I first inquired about the criteria to choose one or more ETFs suitable for my requests.
Let’s talk a little bit about the 8 criteria.
#1 – Reference Index
The starting point of the analysis is to understand which is the reference Index of the ETF and its composition.
Just to make an example, this how it appears on justetf.com the presentation page of one of the most famous ETF in the world, the iShares Core MSCI World:
Here you can find many useful information: the investment strategy of the ETF, fees, dividend distribution policy, fund currency and so on.
By clicking on “Factsheet EN” you open a very useful pdf page, where you can check out the composition of the ETF, its sector breakdown and the countries that it covers. In the example case, you can find this pdf here. Open it and try to understand all the information it contains. This is a very important step to understand how the ETF is composed.
#2 – Index Tracking
Next to the Factsheet link in the presentation page, you can also see the KIID link. The KIID is a document that has the goal to make things clearer about the investment policy, risk and reward profile, charges and past performance of the ETF.
You need to check if the risk related to a particular ETF is suitable for your risk tolerance. If the ETF’s risk is too low or too high related to your risk tolerance, my suggestion is to not invest in the ETF.
In the KIID we also have to check the past performances of the ETF, in order to evaluate the volatily of the ETF.
These are the past performance of the iShares Core MSCI World:
As you can see, in this case the ETF’s performance are quite similar to the index performance. This means that this ETF is volatile as much as the index.
My suggestion is to choose ETF’s with similar performance of the Reference Index.
#3 – Replication Method
One more important thing to keep in consideration is the Replication Method adopted by the ETF.
It can be a Physical replication (Full replication or Sampling) or a Synthetical replication.
The main difference between the two methods are the underlyings: in the first case the underlyings are Equities and Bonds, in the second case they are Equities, Bonds, Commodities, Money Market, Short and Leverage indices.
For instance, the iShares Core MSCI World adopts a Physical replication with optimized Sampling.
If you want to read more about this topic, I suggest you to read the page that justetf.com dedicated to it.
#4 – Fund Size
As you can see from the presentation page, every ETF has a different Fund Size. In the example before, the Fund Size of the iShares Core MSCI World is GBP 14,764 m. It is huge!
My suggestion for this point it to avoid small ETFs because in general bigger funds have lower costs and replicate the Reference Index in a better way.
#5 – Fund Age
Every ETF has a different Inception Date (the day on which it was born). The iShares Core MSCI World was born on 25 September 2009, almost 10 years ago.
In this case my suggestion is to avoid ETFs born less than 2 years ago, because we still have very few data about them.
#6 – Current Expenses
As you probably know one of the biggest advantages related to ETFs is their low cost. It is absolutely important to invest on ETFs with very low expenses.
So always remember to check the expenses related to an ETF before investing on it.
In the example of iShares Core MSCI World, it has very low expenses (0,20% per year), as you can see in the presentation page inserted before.
#7 – Liquidity
One more important criteria to keep into consideration is the Liquidity of an ETF, that will determine the ease and speed with which you will be able to buy and sell fund shares. Here the important thing is to choose ETFs with enough liquidity in order to reduce the liquidity risk and the spread risk.
#8 – Dividend Distribution
Finally, the last criteria is about the Dividend Distribution of the ETF.
The dividend policy can be characterized by the reinvestment of the dividends (Accumulating policy) or their distribution to the investor (Distributing policy).
Here you have to choose ETFs suitable for your investment strategy: you can use one of them or combine ETFs of the two typologies.
In the infographic below I listed the 8 main criteria that we should take into consideration while choosing an ETF. Feel free to download this infographic.
Note that this is my opinion, not the divine truth. I decided that I will use these criteria to choose the ETFs to invest on, and I hope that they can be helpful also for your choice.
I hope this list is as useful to you as it was for me! If something is not clear feel free to leave a comment or contact me through the Contact Page. In any case I’ll try to help you!
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