Lesson 3: Seven steps for choosing the most suitable ETFs

Hi, everyone!😄 Welcome to this session of the Tiger Academy, “ETFs for Beginners”

In the previous lesson, we learned the classification of ETFs and mastered the knowledge and characteristics of different types of ETFs. But how do you decide which ETF is best for you?

In this lesson, I will explain in seven steps.

1. Set investment goals
The first step in choosing an ETF is to set your personal investment goals.

Each investor's expectation of returns and risk tolerance are different. So, before you start investing, you need to know what you want to achieve from your investments and how much risk you are willing to take. This will help you choose the right one.

（1）Low appetite for risk
Risk appetite corresponds to your target for investment returns. When risk appetite is low, your returns will naturally be relatively low.

If your appetite for investment risk is relatively low, you can choose assets such as bond ETFs or currency ETFs.

Go to the " Popular ETF" section of the Tiger trade app, select "Smart Filtering" and then select "Bond" from among the ETF types to see various types of bond ETFs.

If your risk tolerance is low, or if you are not willing to take high risk, opt for things like currency ETFs, municipal bond ETFs, or mortgage-backed bond ETFs. Of course, you’ll also have to be ready to accept lower investment returns.

(Source: Tiger Trade app)

By contrast, if you can handle a little more volatility, an emerging market bond ETF or a high-yield bond ETF is a good choice.

（2） High appetite for risk
If you have a higher appetite for risk, you will want to have a wider range of ETFs in your portfolio, with a focus on equity ETFs or alternative asset ETFs.

For example, if you’re very bullish on gold or oil, choose commodity ETFs. If you're bullish on the energy sector, look for energy ETFs. Bullish on the financial industry? Choose a financial ETF.

Once you’ve figured out this step, you'll see that the scope of investment narrows from the broader ETF market to specific areas. Next, do a more precise screening within these investment areas to find suitable ETFs.

2. Look at the valuation
There are three common valuation indicators: price-earnings ratio (PE), price-to-book ratio (PB), and price-to-sales ratio (PS). The specific definitions of these three indicators have been discussed in previous courses：US Stock Market investing for Beginners


These indicators will all help you evaluate the ETFs valuation before making any decision regarding investing.

3.Look at liquidity

The third step is liquidity, which in the stock market generally represents the ease of trading.

Liquidity includes not only the speed at which an order can be placed, but also the cost of the transaction, the number of shares available to trade, pricing deviation, and so on.

Liquidity is one of the key indicators to look at when choosing an ETF. After all, no one wants to be stuck in an investment position!

So how do we assess the liquidity of an ETF?

Generally speaking, the most common ETF liquidity indicators mainly look at the intraday turnover rate and total intraday turnover. Take the Nasdaq 100ETF (QQQ) for example, which is available on the Tiger Trade app market page:

(Source: Tiger Trade app)

The higher the turnover rate and total turnover, the better the liquidity of the ETF and the higher the transaction efficiency of the order. But when the turnover rate of an ETF keeps rising, it also means that the price of the ETF can fluctuate greatly, and the volatility increases as well.

4、Look at the discount rate and the premium rate

Discount and premium are common concepts used to trade ETFs and are easy to understand.

For example, if we buy $100 worth of clothing at a shop for $70, the discount is 30%. If you buy a $100 dress for $110, the premium is 10%.

Everyone wants to pay less for their clothing and the same goes for ETFs. The bigger the discount, the better off you are at that particular point in time. So, by looking at discount and premium ratios, we can clearly assess whether an ETF is overpriced or underpriced.

For example, search the Tiger Trade app for the Nasdaq 100ETF (QQQ) and find the discount data on the quote screen:

(Source: Tiger Trade app)

The discount/premium rate shown in the figure above is 3.4%, indicating that the current transaction price is 3.4% higher than the actual net value, which is a premium transaction. This tells you that the current transaction price is relatively overpriced.

If you come across an ETF with a high premium rate, buy with caution.

5. Look at the tracking error
In the previous class, we said that the goal of an index ETF is to track the target index and rise or fall with the value of that index so as to achieve the same investment return.

In short, if you're particularly bullish on an index, find an ETF that tracks it.

Because the components of an index ETF will exactly mirror the components and weights of the target index, certain errors - known as tracking errors - will be generated during trading due to market fluctuations, buying and selling costs and other factors.

The larger the tracking error is, the greater the difference between the net value of the fund and the trend of the index it tracks, and the greater the risk of the fund manager’s active investment.

A tracking error above 2% is generally considered a large error.

6. Look at the fees

We mentioned earlier that actively managed ETFs typically have higher expenses than index ETFs. It's important to note, however, that even ETFs that track the same index can have different expense rates.

Take a look at three ETFs that track the S&P 500：

As can be seen from the table, the total management expense of SPY is significantly higher than those of IVV and VOO when tracking the S&P 500 index.

The expense ratio is not the only thing we look at when deciding whether or not to buy an ETF, but if everything else is the same,, the lower the expense ratio, the better.

7. Look at the ETF issuer and ETF size

The final step is to look at the issuer of the ETF as well as the size of the ETF. Take a look at these three ETFs that track the

（Data source: Wikipedia, the statistical period is up to 2020）

As shown in the figure, SPY was issued earliest and has the largest scale.

So, what are the effects of ETF issuer and size?

（1）ETF issuer
Generally speaking, the size of an ETF issuer is closely related to ETF tracking error, cost of fund operation, liquidity and other factors.

With large scale issuers that have issued many types of funds, the fund managers and the investment and research teams will be more complete, and the investment and research will be stronger.

Having gone through the ups and downs of the market, large ETF issuers will also have more experience and credibility.

(2) ETF size

Many investors would argue that bigger is better, because the bigger the ETF, the more liquid it is.

But for regular investors, as long as an ETF can meet daily trading needs, it has market makers, and isn't too small (being too small carries liquidation risk), we don't need to be too picky about the size of an ETF.

That concludes the seven main steps to choosing an ETF. In our next class, I'll show you the simplest way to trade ETFs.

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Disclaimer: The information herein was prepared for educational purposes, and does not constitute an offer, recommendation or solicitation, nor does it constitute any prediction of likely future stock performance. In preparing this information, we did not take into account the investment objectives, financial situation or particular needs of any person or affiliated companies. Before making an investment decision, you should speak to a financial adviser to consider whether this information is appropriate to your needs, objectives and circumstances. Tiger Brokers assumes no fiduciary responsibility or liability for any consequences financial or otherwise arising from trading in securities if opinions and information in this document may be relied upon.This advertisement has not been reviewed by the Monetary Authority of Singapore.