ETFs make investing easier for people who do not have the time to dive deep into researching the stock market.
Exchange-traded funds, or ETFs, give investors exposure to numerous stocks, making it easier to diversify portfolios. That certainly came in handy as markets turned rougher this past week. However, portfolio diversification doesn't mean much if a fund tends to lose money or doesn't achieve its objective.
While the stock market doesn't offer any guarantees, top-rated ETFs have a higher chance of delivering on their promises. Whether you want to beat the market or generate high cash flow without much volatility, an ETF with a five-star rating from Morningstar is more likely to get the job done.
While the stock market doesn't offer any guarantees, top-rated ETFs have a higher chance of delivering on their promises. Whether you want to beat the market or generate high cash flow without much volatility, an ETF with a five-star rating from Morningstar is more likely to get the job done.
Stuart Schiffman, founder and managing partner of Compound Wealth Advisors, says that investors can view Morningstar as one reliable resource for their ETF research: "Morningstar regularly reviews most ETFs and rates them two ways. The first rating is based on past performance relative to peers. These rankings range from 1 to 5 stars. The second rating system is based on a review of five key metrics related to performance, such as manager experience and investment process. Analyst rankings range from neutral to gold star."
What Are the Advantages of ETFs?
Investors can find ETFs that follow a wide range of strategies, such as mirroring the S&P 500 or using covered calls to boost their yields. ETFs allow investors to take a hands-off approach instead of being actively involved in the stock market. Steven Conners, founder and president of Conners Wealth Management, says it's even easier if you focus on passive index funds: "Many ETFs track an index, which allows for less due diligence compared to an individual stock (or bond). For example, SPDR Dow Jones Industrial Average ETF (ticker: DIA), State Street's Dow Jones ETF. It just tracks the Dow Industrials," he says.
How to Analyze an ETF
While an ETF that has good historical returns may look promising, it's important to conduct a deeper dive into any fund before buying shares. The first step to investing in an ETF is to be familiar with the holdings and confirm a low expense ratio, good performance history, liquidity and tax efficiency.
You'll also want to determine your risk tolerance and how an ETF aligns with your long-term financial goals. Analyzing your own financial situation is paramount to choosing the right ETF for you, since each investor is different. Whether you're focused on long-term growth, the lowest possible risk, a new income stream or diversification into international markets, your financial parameters will determine how you want your ETF holdings to perform. For example, if you need income, a dividend-paying ETF works well, but if you're mostly focused on safety, a bond ETF can provide stability. Emerging-market ETFs as well as long-term index funds can provide diversification.
Each of the ETFs on this list have earned a five-star rating from Morningstar and have outperformed the S&P 500 over the past five years: