ETFs are the simplest portfolio-building tool of all, but let's not pretend it's simple to choose the right ones for your portfolio.
The vast and ever-growing number of exchange-traded funds available to investors is only part of the problem. There's also the challenge of finding and deciphering the information needed to make smart choices.
To help newcomers to ETF investing, here's Part One of a two-part tutorial.
1.) Your go-to source of information is the websites of ETF companies themselves.
Use a website like Globeinvestor.com for quotes, charts and commentary on ETFs. For data on fees, holdings, yield, tracking error and more, your best source of information is the fund profiles all ETF companies provide on their websites. The quality and clarity of the info presented varies widely, but the basics are there in almost all cases. For screening ETFs, try the website ETF Insight; for ETF research, see what your online broker has to offer.
2.) Understand ETF fees
To start, ETF returns are always reported on an after-fee basis. The definitive measure of fund fees is the management expense ratio, or MER, but some ETF companies show only a major component of the MER called the management fee. If you see only the management fee, figure on the MER being up to 0.01 to 0.7 of a percentage point higher in most cases. ETF companies have been cutting fees on some of their core products in the past 18 months, which means some ETF data sources may have outdated info. Always double-check fees against what's shown on the provider's own website.
3.) Understand returns, Part One
ETF companies typically display total returns, which means changes in share price plus the yield from dividends or bond interest. If the returns you see on other websites don't square with the numbers on ETF company websites, it may be because you're looking only at changes in share price.
4.) Understand returns, Part Two
Why do returns for ETFs tracking the same index sometimes differ a bit? It's tracking error, the term that describes the gap between the return of an index-tracking ETF and its target stock index. Ideally, tracking error would be the amount of the MER. If you're looking at funds with currency hedging, expect this feature to add to tracking error.
5.) Understand yield information
Regulators could really do investors a favour by standardizing the yield data shown for ETFs holding dividend-paying stocks and bonds. You may find:
- 12-month trailing yield: An after-fee number based on the previous 12 months of distributions dividend by net asset value at the end of the period
- Annualized distribution yield: An after-fee number based on the latest distribution extrapolated over 12 months and then divided by the latest net asset value.
- Weighted average dividend yield: A before-fee number showing yield based on the proportion of the fund in each of its constituent dividend-paying stocks.
- Weighted average yield to maturity: This before-fee number is a definitive measure of what to expect from bond ETFs going forward.
NEXT: Five more tips for understanding ETFs.