ETFs: Separating the Good from the Bad

by Nancy Zambell | September 9, 2012 8:00 am

ETFs: Separating the Good from the Bad

In my last article[1], I discussed exchange-traded funds, their pros and cons, and the most important characteristics that investors need to know before choosing from the 1,400-plus ETFs now on the market.

Many investors frequently make the mistake of chasing returns and blindly select ETFs that have the highest short-term gains. That’s a big mistake!

Unfortunately, the ETF world has caught up with the equity marketplace, with investors abandoning a long-term outlook and instead jumping on the next “hot” idea. This has led to the proliferation of a variety of ETFs, many that are thirstily sucking up investors’ hard-earned money. But on the bright side, innovation in the ETF space also means investors now have a broad choice of different ETFs to select from.

The key is — as with any investment — separating the good from the bad.

Let’s first take a look at the different types of ETFs available to you today, beginning with those that are weighted by alternative parameters:

Then, there are a host of fundamentally weighted ETFs, sometimes called “intelligent” or “smart” ETFs, which weigh companies by fundamental measures such as company size, sales, profits, dividends, growth and value. These include:

Investors should note that fundamentally weighted ETFs often carry higher fees than market-cap or equally weighted ETFs, since, allegedly, these ETFs require more manpower and man hours to manage.

trans ETFs: Separating the Good from the Bad

There are just a few more categories of ETFs that I want to talk to you about today — ETFs that should mostly be avoided by the average investor:

As you can see, ETFs are no longer vanilla, market-weighted funds based on broad indices. Consequently, it’s investor beware.

I’m not suggesting that you should only buy the basic, market-weighted ETFs. In fact, I like a lot of the fundamentally weighted ETFs and think investors should hold a variety of these, based on your own investing strategy and goals. An investor who doesn’t have a lot of time to dedicate to his portfolio easily can create a diversified portfolio of profitable ETFs — for the long term.

But please make sure you read the fine print. Go beyond returns and examine the ETF, just like you would any other investment. And if you are not a very experienced, sophisticated market maven, some of the esoteric, more complicated ETFs should be avoided at all costs. Why risk your hard-earned money for something that is difficult to understand and fraught with major downsides?

You still can achieve market-beating returns if you select well, diversify and pay a bit of attention to market cycles so you can structure your portfolio to take advantage of the best ETFs during downturns and bull runs.

Next up: 5 ETFs to Buy for Growth in 2012[2]

Endnotes:
  1. my last article: http://investorplace.com/2011/12/how-to-pick-good-etfs-bad-etfs/
  2. 5 ETFs to Buy for Growth in 2012: http://investorplace.com/2012/01/5-etfs-to-buy-for-2012/

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