Use Exchange Traded Funds (ETFs) When Unsure About Which Stocks to Buy

With the stock market rallying, many investors want to participate in the gains but don’t know which stocks to buy. For example, you’ve heard that the tech sector is sizzling and well known names like Google (GOOG) and Apple (APPL) are reporting stellar earnings – but still don’t know which one has the best long term potential (and what about other tech stocks). And is it worth investing in one or both of these stocks – which is not a cheap proposition either with the stocks priced over $150 and $400 respectively.

If you are like me with a day job and a family to care for, there is just not enough time in the day to pick individuals stocks in a consistent and disciplined manner. Further like many retail investors, last year’s investing experience has made me quite risk averse when it comes to putting all my money in a handful of stocks. However there is an easy and lower risk solution available – Exchange traded funds. An exchange-traded fund, or ETF, is an investment product representing a basket of securities that track an index or sector such as the S&P 500 or commodities. They are among the most popular form of investing because they offer the diversification benefits of mutual funds (at a lower cost), but trade just like stocks.

Finding the Right ETF

Just like stocks and mutual funds there is no shortage of information available online about ETF’s. The problem has almost become that there is too much information. Personally I like to use my online broker’s research tools (see next section), the Wall Street Journal, Bloomberg, and well known funds research site Morningstar for researching the various ETFs available for a sector or index I want to invest in. If you are a new investor and looking for some straightforward and free information I recommend you start at Morningstar where you can sign up for a free subscription. Their site provides a lot of education information on ETFs and some of the best (and easiest to use) screeners to find the right one for you.

As an example, suppose you feel that the health care sector is going to be strong for the next year thanks to the Obama health care reform plan and you want to find a large but low cost ETF to invest in the sector. Go to the ETF section of the Morningstar site and click on the (new) ETF screener. It has some predefined criteria like expense ratio and performance, but you can use the add criteria dropdown to select more. Use the Morningstar sector weightings and select health care. Add this criterion and you will see over 200 potential ETF’s returned. To get a more refined list add or change other criteria. Once you play around it for a bit you will get use the tool and the best thing is that you can save your ETF screen for future use. For analyst recommendations, advice and more detailed analysis you can also sign for their paid premium section

If you are feeling particularly bullish or bearish about a specific sector or index you can also buy leveraged ETFs to get double or triple the exposure for moves in the underlying stocks. This is akin to the kind of exposure you have with index options and is definitely for the more seasoned investor, but worth considering once you get comfortable with basic ETF investing.

How to Buy and Sell an ETF

Buying an ETF is just like buying a stock. The key is finding an easy to use discount broker that offers low trading cost. Online brokers I recommend and use is leading online broker E-trade, which is the best option for those who want a lot of good investing 101 topics, access to an extensive amount of analyst research and a one stop place to manage their stocks and banking. However if you plan to trade more often and the focus is on getting the lowest trading costs (free to less than $5) then go with award winning ultra-discount brokers Zecco (which has a good free trade option) or TradeKing.

When you have decided which ETF to buy (after doing your research I hope!), just execute the trade via your online brokerage account like you would a stock. Your broker will execute the ETF transaction process on the relevant trading exchange and you should then see the ETF added to your trading portfolio. Like any investment, make sure you monitor it and the sector or index it tracks. Selling the ETF through your broker is just as simple and transaction costs should be the same as for stocks.

ETF’s come in all shapes and sizes and can be bought to profit from falling and rising markets. I think they are a much safer way for investors to use in volatile markets and given trading costs for ETF’s are the same as stocks, it makes good financial sense to use them over the longer term.

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