Perform These 3 Tests Before You Buy an ETF

Michael A. Robinson

Quick: Choose between buying a biotech exchange-traded fund (ETF) that trades about 2.3 million shares a day or a tech ETF that trades less than 7,300 shares per day.

If you chose the biotech ETF, in this case you'd be wrong – but I understand your decision there.

After all, to make money in tech stocks you must consider volume, along with price action, fundamentals, and other factors. That's because some micro-cap stocks are so thinly traded that you might not be able to get out quickly should you need to.

Personally, I like to see at least 50,000 shares trading hands daily on small caps – and much more for larger firms. And 7,300 shares a day is far below those sorts of numbers.

However, when it comes to ETFs, volume is much less important than three other metrics you should consider when looking at these funds.

These three elements can mean the difference between riches and financial ruin.

So let's break them down…

ETF Nation

The whole idea behind ETFs is to buy a basket of stocks in one fell swoop. By doing so, you gain instant diversification.

You can go as broad or narrow in your focus as you like. You could buy an ETF that's tied to the S&P 500, one that's pegged to small caps, or one that specializes in, for example, semiconductors or cybersecurity.

This is an asset class that belongs in every tech investor's portfolio. If you don't have the time or ability to pick the winners from the losers, with ETFs the stock experts do the heavy lifting while you pocket the gains.

No wonder they're so popular…

The total size of the U.S. ETF industry has increased by nearly 19% over the last 12 months, according to an analysis by Forbes. The global ETF market is worth some $4.94 trillion.

Not bad for an investment that got its start less than 25 years ago, in early 1993 with just one ETF. Today, there's no shortage to choose from. As of late 2017, there were nearly 5,400 ETFs traded globally, up from about 4,800 at the end of 2016.

Now, here's why volume should not be the deciding factor when you sit down to choose an ETF to invest in.

Unlike stocks, ETFs don't really rely on volume for true liquidity. Rather than in the ETF itself, we look for good volume in the stocks the fund holds.

If you want a way to get rich, this is all you need to know…

Let's say you find an ETF that tracks the S&P 500 but has volume of just 10,000 shares a day. That sounds illiquid. However, the stocks represented by this fund trade hundreds of millions of shares a day.

Should the ETF's price drift too far from its net asset value, asset managers known as authorized participants can step in to buy or sell shares. For that reason, even thinly traded ETFs will almost always closely track their underlying indices.

So instead of wasting time looking at volume, consider using these three ETF "Profit Screens" when searching for a fund to buy…

ETF Profit Screen No. 1: Expense Ratio

ETFs have gained so much popularity because of their low overhead compared to mutual funds, some of which can have management fees of 5%.

For my money, I rarely buy an ETF with an expense ratio above 1% – and I prefer 0.5% or even lower.

If you're considering two ETFs with similar ratings and performance, then choose the "cheaper" one. For instance, a semiconductor ETF with an expense ratio of 1% has double the overhead of one whose expense ratio is 0.5%

ETF Profit Screen No. 2: Morningstar Rating

Michael A. Robinson

About the Author

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Michael A. Robinson is one of the top financial analysts working today. His book "Overdrawn: The Bailout of American Savings" was a prescient look at the anatomy of the nation's S&L crisis, long before the word "bailout" became part of our daily lexicon. He's a Pulitzer Prize-nominated writer and reporter, lauded by the Columbia Journalism Review for his aggressive style. His 30-year track record as a leading tech analyst has garnered him rave reviews, too. Today he is the editor of the monthly tech investing newsletter Nova-X Report as well as Radical Technology Profits, where he covers truly radical technologies – ones that have the power to sweep across the globe and change the very fabric of our lives – and profit opportunities they give rise to. He also explores "what's next" in the tech investing world at Strategic Tech Investor.

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