Finding the Right ETF

ETFs first came on the scene here in the United States back in the early 1990s, but they have really taken off in recent years. There were about 100 ETFs available just a couple of years ago, and now there is a dizzying array of more than 500 with more than $500 million invested!

Typically, ETFs are purchased by investors based on their investment objectives, risk tolerance, past performance and future projected performance of the individual underlying index or particular market sector. For example, if you are particularly bullish on a certain sector, ETFs allow you to buy a market basket of stocks within that sector, such as telecommunications, China, technology, health care, energy, emerging markets - and many others.

Dolan Smart Money Move: We recommend that you look for low-cost, well-diversified ETF funds. Some of the more popular ETFs are the broader-based ones such as the Rydex S&P Equal Weight Fund and the iShares S&P 1500 Index Fund, both of which essentially track the S&P Index.

Many issuers of newer ETFs are scurrying around to find exciting new funds to sell in specific sectors and countries, but we want to caution you here: Be very wary of investing in ETFs with less than $200 million dollars in the fund, funds with less than three years of track record, and funds that track a very narrow index in a particular sector.

In our opinion, they are just too risky.

The rise in popularity in ETFs means the competition is fierce for investor dollars, and some of the very narrow index ETFs could close down if there is lack of investor interest.

One thing we especially like about ETFs is they generally publish their holdings every day, so you are able to easily see which shares are held in the fund anytime you want. This is different from mutual funds, which are priced only ONCE per day (when the market closes at 4 p.m. ET), and you have to wait until the end of the quarter to see in which shares your money was invested - looking BACK!

As we mentioned earlier, we're also big fans of the generally lower costs associated with ETFs. They have an average annual expense ratio of 0.41%, compared with 1.42% for the average diversified domestic stock mutual fund. That's nearly 3.5 times more for mutual funds.

Why the difference? Management fees are less, as we already talked about, and there are also fewer transactions in ETFs because the indexes or sectors they track tend to stay mostly the same. Fewer transactions result in lower fees.

Dolan Warning: Be aware, however, that you will have to pay a brokerage commission every time you buy or sell shares in an ETF. We don't want you to succumb to trading ETFs (or any other investment for that matter). ETFs may also not make sense for you if you're interested in buying shares on a regular basis. The transaction fees will add up in a hurry.

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