How to Choose ETFs

Justin Ling Updated by Justin Ling

You'll want to start by understanding the function of ETF's. Click here, to see our definition of ETF's. 

Choosing ETF's Using EquitySim Discovery

There are many methods that can be used to evaluate the value of a stock or ETF (Exchange Traded Fund). Some are simple and some require extensive research and analysis. But if you’re just getting started, and you’re thinking of investing in individual stocks or ETFs, here are some simple guidelines.

1. The best place to start is thinking about companies, industries, or themes you are interested in.

When looking at individual stocks, the more you know about the company, the products they sell, and how the business operates, the better. If you really love Nike’s products, know the company’s management well, and understand its market, it could be a good place to start. You can then try to find similar companies that belong to the same industry and are around the same size (market cap is a good indication of this).

Because ETFs consist of hundreds, and even thousands, of individual securities, ETFs can be approached on a more holistic level. Here is where themes, industries, and region come into play. If you think artificial intelligence is the next big thing, then you could look into an ETF that captures that view, like BOTZ. If you think Emerging Markets is where you want to be, you could invest in an ETF like EEM.

Looking at an ETF’s holdings is also a great way to narrow down your stock search and find new companies in industries you’re interested in.

2. Think about how much risk you want to take on.

There are lots of measures of risk, but here are some simple ones to get started.

A simple way to get an idea of how risky a stock or ETF is is to look at a stock’s volatility. A security with higher volatility means that its price fluctuates more. This means that there’s a higher probability that the price of the security will move in either direction. Think of how much movement you’re comfortable with before deciding on a stock or ETF to invest in.

Another way to get a sense of risk when investing in stocks is looking at a company’s market cap (stock price x shares outstanding). Market cap shows how large a company is, in terms of valuation. Usually, the bigger the company, the less likely it is that it will go under. It may also mean that there is less room for it to grow.

Thinking about the stock or ETF in a broader sense is also helpful. For example, is the stock or ETF exposed to risks that are particular to a certain industry or region?

3. Decide if you’re looking for income or appreciation.

Do you want to make a profit from market price movements or do you want a steady payment stream?

This is where dividend yield comes into play. If you’re looking for income, look for companies or ETFs with a higher dividend yield. Companies that pay out steady dividends tend to have more stable prices.

If you’re looking for appreciation, try investing in companies or ETFs that you think will rise in value from a price perspective.

4. Think about what your overall portfolio looks like and diversify!

If you’re over-exposed to specific industries or regions, it could be a good idea to invest in areas that aren’t related to the performance of your portfolio or are inversely related. For example, if your portfolio is mostly in airlines (who benefit when oil prices are down), it could be wise to invest in oil ETFs too. That way, if oil prices rise, your entire portfolio won't suffer.

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