How ETF Experts Pick Funds

Exchange-traded funds have become enormously popular, and there are now about 900 of them. For many investors, they offer a mutual fund alternative with lower costs, easier trading and better tax efficiency.

ETF shopping, then, can boil down to a side-by-side comparison of an ETF and a comparable fund. If performance is the same, costs and other features would probably favor the ETF.

But it can be a mistake to stop your research there. Because ETFs are structured differently from funds, investors should ask a few extra questions, according to Financial Planning, an information service for independent advisers. Financial Planning asked two ETF experts about what financial advisers should look for in choosing ETFs for clients.

Some of the answers apply only to very large investors, such as whether a big trade could affect the ETF’s price. But some of the experts’ points apply to small investors as well.

One is to assess the fund’s liquidity, or how easily it can be bought and sold. It’s better to choose funds with at least $50 million in assets, because more assets suggest better liquidity, said Tom Lydon, president of Global Trends Investments, a financial advisory firm that specializes in managing clients’ ETF portfolios.

Investing in an ETF with poor liquidity could make it hard to sell, and it could increase chances the ETF’s share price would poorly reflect the true value of its assets.

John Gabriel, an ETF analyst at Morningstar (Stock Quote: MORN), said shoppers should also look at the bid/ask spread, or the difference between what buyers are offering for the ETF’s shares and what sellers are demanding.