How to Choose an ETF

Exchange-traded funds (ETFs) have become an increasingly popular way for investors to add tax-efficient, low-cost diversity to their portfolios.¹ With more than 3,500 ETFs available in the United States,² navigating these options can seem overwhelming.

Here are a few guidelines to help you navigate, evaluate, and select the ETFs that work for your investing objectives:

With a wide range of ETFs to choose from, it can be helpful to winnow the options. One way to start is by identifying your financial goals and then considering what type of ETF you might want to purchase based on those goals.

If you’re seeking to supplement your income, you may be interested in income-earning equity or bond ETFs in an effort to help bolster finances. If you’re in it for the long run, perhaps you’d like to take advantage of a currency you think might become stronger in the future or invest in the current real estate market with REIT ETFs.

Questions you may want to consider include:

• Are you building or complementing a portfolio?
• Is generating income important to you? 
• How comfortable are you with volatility?
• Do you want to express a specific view on the markets? 
• Are you looking for lower-cost investments?
• Are you interested in a specific asset class—e.g., stocks, bonds, currencies, etc.?

There's an ETF for almost any goal, so starting with your big picture objectives will help narrow your search.

Though ETFs can have lower costs than other types of investment products, they do come with expenses. To help estimate the cost-efficiency of an ETF you’ll need to understand the expense ratio and the tax impact.

• What is an expense ratio?

An ETF’s expense ratio is the annual fee charged to shareholders to cover the fund’s yearly expenses. This includes operational costs for things like portfolio management, trade execution, and more. The average ETF expense ratio is approximately 0.36%³ which means you’ll pay an average of $3.60 in annual fees for every $1,000 invested.

Many ETFs can keep their costs low because they are passively managed, simply aiming to match the performance of a benchmark index before expenses. When determining the value of fees, keep in mind the service you receive in exchange. Since the fee reflects the size of your portfolio, it will grow if your portfolio grows. You can find the expense ratio by viewing the ETF’s prospectus.

• How do taxes work with ETFs?

Due to their unique structure, ETFs can have an advantage over other investments when it comes to taxes since their structure typically allows ETFs to experience fewer net realized capital gains. For investors utilizing taxable accounts, investing in ETFs could increase their returns on an after-tax basis, as compared to investing in a similarly managed mutual fund. Please consult with your tax advisor on the tax implications of investing in mutual funds and ETFs.  E*TRADE does not provide tax advice.

Like any investment, ETFs come with risks. Beyond market volatility and price drops, here are some unique issues that investors should carefully consider.

• Trading risk - The market determines ETF share prices. Since ETFs trade like stocks, they have a bid-ask spread, meaning there can be a difference between what a trader wants to sell their shares for and what the market will pay. As a result, ETFs can trade at substantial discounts to the value of the ETF's underlying holdings, negatively impacting shareholders, particularly those that need to sell their shares at such times.
• Tracking error risk – Many ETFs are designed to track a specific index or the value of an underlying asset. However, due to the fund’s management, fees, and market fluctuations, the ETF’s position may deviate from the index or asset benchmark it was originally designed to replicate.
• Active-management Risk – Other ETFs are actively-managed and try to beat a specific index or other benchmark. There is no guarantee that an actively-managed fund will outpace its index or benchmark.

Further, every ETF has specific risks that correspond to its particular investment objective and strategy. You can find more information on an ETF’s risks by reviewing its prospectus. Understanding what's in the ETF’s portfolio, including its largest holdings, industry, and geographic location, can provide additional insight into its potential risks.

So, now that you’ve defined your goals, narrowed the ETF universe, and reviewed your risks, are you ready to get started with ETFs?

The E*TRADE from Morgan Stanley ETF Screener allows you to filter and focus on finding ETFs based on your guidelines. You can search through more than 2,000 exchange-traded funds by using a variety of criteria, such as:

• Predefined strategies
• Fund category
• Morningstar rating
• Expense ratio
• Previous close
• Fund characteristics
• Market return
• Yield

You can also choose to get some help from E*TRADE:

• Invest using our Prebuilt portfolios where you select your risk tolerance and easily invest in diversified, professionally selected portfolios of mutual funds or exchange-traded funds (ETFs). And you pay no trading commissions although fund fees and expenses still apply.
• Build, manage, and rebalance a diversified ETF for yourself in Core portfolios.
• Find ETFs that align with your values or with social, economic, and technology trends in Thematic Investing.
• Choose from a list of Choice ETFs evaluated by Morgan Stanley Smith Barney, LLC.

When you find an ETF that meets your objectives, you can purchase it or sell it (like stock) using the standard range of order types, including market, limit, and stop orders.

Article Footnotes

¹ press_release_2023_10_26_SMAs_Grow_Mutual_Funds_Decline_Competitive_Imperative_Asset_Managers.pdf (heartsandwallets.com)

² ETFs in 2023: A Tale of Success and Failure | Morningstar, Jan. 5, 2024, https://www.morningstar.com/funds/etfs-2023-tale-success-failure

³ The Annual US Fund Fee Study From Morningstar | Morningstar, https://www.morningstar.com/lp/annual-us-fund-fee-study

CRC# 3811307 12/2024