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3 Tips For Finding Your First ETF

Finding your first exchange-traded fund (ETF) is much the same as searching for a new TV. You know you have a specific need that is easy to fulfill in today’s expansive marketplace. However, the list of options is overwhelming, prices vary wildly, and opinions from friends or family can be conflicting. There is a confidence gap that must be filled through a combination of research, observation, and experience.

Fortunately, there are several ways to easily narrow this gap so that you can make a poised decision with little risk of regret. The following are tips for both new investors who are just getting started on this journey and those who have decades of investing experience.

1. Limit your field of options

There are currently 1,974 exchange-traded products available to U.S. investors. That’s a ridiculous number of options that even experts have a difficult time keeping straight. The first step in your journey should be to limit your field of choices to make the decision easier.

A simple way to do this is to consider just the top 25 funds by asset size. These are all very low-cost, liquid, and tax-efficient vehicles across a wide variety of asset classes. Every single one tracks a passive index – so you know exactly what you own and why you own it. The default screener at ETF.com sorts funds by asset size (largest at the top), which makes this list an automatic advantage for new users.

Another excellent way to narrow the entire universe is to look at the list of transaction-free ETFs on your brokerage platform. The major providers such as Vanguard, Fidelity Investments, Charles Schwab, TD Ameritrade, and E-Trade all offer curated lists of ETFs you can buy or sell with no commission. These menus also cover a broad subset of asset classes and styles that make for excellent choices.

With transaction-free ETFs, you can buy as little as one share at a time without worry about costly fees eating into your returns. These funds are perfect for smaller accounts or those who want to contribute to their investment portfolio on a regular basis.

2. Evaluate your current portfolio and needs

In some ways, finding the right ETF to fit your needs is easier if you have already established positions in mutual funds or individual stocks. A quick look at the style of your mutual fund or the sector concentration of your stock portfolio will illuminate what type of ETF you can replace it with. For example, a large-cap value mutual fund may be easily replaced with a low-cost ETF such as the iShares Russell 1000 Value ETF (IWD).

You may also be able to replace multiple stocks in the same industry with a diversified sector fund. For instance, if you own four or five large-cap health care stocks, you may find that it’s easier just to hold the Health Care Select Sector SPDR ETF (XLV) instead.

Conversely, those that are starting with an all-cash portfolio must first decide what the asset allocation is going to be and how to vary the fund style parameters. You may decide to hold both U.S. and international funds, weight your portfolio towards a specific theme like growth, or even add a smattering of commodity exposure.

One word of caution is to not overly complicate your first selections. Start with one or two ETFs that are highly diversified and meet your basic exposure needs. It may be as simple as selecting a fund like the Vanguard Total Stock Market ETF (VTI), which is a fantastic all-purpose solution for mirroring the performance of U.S. stocks. The iShares Core U.S. Aggregate Bond ETF (AGG) is the same all-encompassing proxy for the U.S. bond market.

3. Execute your plan

All this research and evaluation is simply theory until the trade is executed. My advice is to start small in both position size and number of ETF selections. That way you can monitor how they perform in relation to the broad market, prior fund holdings, and your overall expectations.

It should also be noted that ETFs are always traded in shares, similar to stocks, rather than the dollar amounts that many mutual funds allow. To figure out the number of share to purchase, simply divide the amount of money you wish to commit by the current share price of the ETF. Then make sure you round to the nearest whole number.

After a period of time has passed and your comfort level begins to improve, it becomes easier to select new ETFs for a specific purpose. You can also begin to explore ETFs with a specific factor or index weighting methodology.

The Bottom Line

I have yet to meet an investor who has been dissatisfied with the level of flexibility, cost, and diversification that ETFs offer versus traditional alternatives. Their transparent structure and dependable tracking make for excellent tools that all types of investors can benefit from. As you become immersed in ETFs as the future of your portfolio, you will likely have a hard time remembering how you invested any other way.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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