Quick: Choose between buying 1) a biotech exchange-traded fund that trades about 2.3 million shares a day, or 2) a tech ETF that trades less than 7,300 shares per day.
If you chose 1, in this case you’d be wrong – but I understand your decision there.[ad#Google Adsense 336×280-IA]After all, I just told you that to make money in tech stocks, you must consider volume along with price action, fundamentals, and other factors.
That’s because some micro-cap stocks are so thinly traded that you might not be able to get out quickly should you need to.
Personally, I like to see at least 50,000 shares trading hands daily on small caps – and much more for larger firms. And 7,300 shares a day is far below those sorts of numbers.
However, when it comes to ETFs, volume is much less important than three other metrics you should consider when looking at these funds.
These three elements can mean the difference between riches and financial ruin.
So let’s break them down…
The whole idea behind ETFs is to buy a basket of stocks in one fell swoop. By doing so, you gain instant diversification.
You can go as broad or narrow in your focus as you like. You could buy an ETF that’s tied to the S&P 500, one that’s pegged to small caps, or one that specializes in, for example, semiconductors or cybersecurity.
This is an asset class that belongs in every tech investor’s – every investor’s – portfolio. If you don’t have the time or ability to pick the winners from the losers, with ETFs, the stock wizzes do the heavy lifting while you pocket the gains.
No wonder they’re so popular…
According to BMO Global Asset Management, the worldwide ETF market grew 10% last year to a record $2.9 trillion. The United States is by far the world’s largest ETF market, with a value of $2.1 trillion, up 6% from the year before.
Not bad for an investment that got its start less than 25 years ago, in early 1993 with just one ETF. Today, there’s no shortage to choose from. My broker, for one, lists 1,900.
Now, here’s why volume should not be the deciding factor when you sit down to choose an ETF to invest in.
Unlike stocks, ETFs don’t really rely on volume for the true liquidity. Rather than in the ETF itself, we look for good volume in the stocks the fund holds.
Let’s say you find an ETF that tracks the S&P 500 but has volume of just 10,000 shares a day. That sounds illiquid. However, the stocks represented by this fund trade hundreds of millions of shares a day.
Should the ETF’s price drift too far from its net asset value, asset managers known as authorized participants can step in to buy or sell shares. For that reason, even thinly traded ETFs will almost always closely track their underlying indices.
So, instead of wasting time looking at volume, consider using these three ETF “profit screens” when searching for a fund to buy…
ETF Profit Screen No. 1: Expense Ratio
ETFs have gained so much popularity because of their low overhead compared to mutual funds, some of which can have management fees of 5%.
For my money, I rarely buy an ETF with an expense ratio above 1% – and I prefer 0.5% or even lower.
If you’re considering two ETFs with similar ratings and performance, then choose the “cheaper” one. For instance, a semiconductor ETF with an expense ratio of 1% has double the overhead of one whose expense ratio is 0.5%
ETF Profit Screen No. 2: Morningstar Rating
Founded in 1984, Morningstar is a leading provider of independent investment research. It covers roughly 525,000 stocks, mutual funds, and ETFs.
The firm assigns one to five stars to each of the investments it covers. I avoid ETFs with less than 3 stars because I believe the quality of the fund is more important than volume.
My broker automatically gives me the Morningstar rating for each ETF I screen. If your broker doesn’t, don’t worry. You can get it for free directly from Morningstar’s website.
ETF Profit Screen No. 3: Trend
Wall Street’s fickle nature means that certain sectors will be in or out of favor at any point in time. In other words, don’t buy an ETF in a sector that the sharks are circling.
That said, you should consider the long haul. You can find great bargains in sectors that are temporarily out of favor. You just have to have the confidence to stay with the trend through the ups and downs.
Let’s You and Him Fight
Now, let’s compare two funds with very different volume levels from among the iShares tech funds from BlackRock, an investment firm with $4.6 trillion in assets under management…
- iShares NASDAQ Biotechnology Index ETF (Nasdaq: IBB)
- iShares North American Tech ETF (NYSE Arca: IGM)
Let’s run both through your new ETF profit screens.
ETF Profit Screen No. 1 – Expense Ratio: Both have cost ratios of just under 0.5%.
ETF Profit Screen No. 2 – Morningstar Rating: Both have four-star Morningstar ratings.
ETF Profit Screen No. 3 – Trend: The difference here is trend. Despite its long-term potential, biotech is out of favor on Wall Street right now.
And thanks to that, IBB has performed poorly over the last year – and volume isn’t helping it any. While IBB boasts average volume of 2.3 million shares a day over the past three months, it has a one-year decline of 23.9%.
By contrast, IGM has gained 5.6% over the past year, a performance that’s more than four times better than that of the S&P 500. [Recent], volume came in at less than 7,300.
Despite that measly volume, IGM is a great vehicle for tech investors. Its top five holdings are, making up 7.92% of the fund, Microsoft Corp. (Nasdaq: MSFT); with a weight of 7.71%, Apple Inc. (Nasdaq: AAPL); with a weight of 6.44%, Amazon.com Inc. (Nasdaq: AMZN); with a weight of 6.26%, Facebook Inc. (Nasdaq: FB); and, with a weight of 3.96%, Alphabet Inc. (Nasdaq: GOOGL).
The fund holds more than 270 stocks in all, including many small- and mid-cap players – everything from satellite communications and the cloud to e-commerce and 3D printing.
Trading at $112.50, IGM is a cost-effective way to invest in the broad array of growth sectors that make tech such a profitable field today. With this one play, you get to invest in all breakthroughs in information technology with an ETF that is top rated and offers low overhead.
This is the kind of foundational play that can really help you build your net worth over the long haul.
And it’s one that many investors would have cast aside had they put too much emphasis on the fund’s volume.
— Michael A. Robinson[ad#mmpress]
Source: Money Morning