Exchange-traded funds have long been touted as a simple, liquid, transparent and tax-efficient solution to gain access to a particular asset class, geography or sector. While this can be true, the myriad of options now available in the market makes choosing the right ETFs a challenge, particularly for complex portfolios.
These layers of complexity aren’t necessarily immediately obvious, just as when searching for a home. When people describe their perfect house, they use multiple criteria. The size, floor plan, yard, number of floors, neighborhood and cost are all good places to start. On paper, it’s easy to try and create a simple list of wants and some buyers treat these criteria as wholly separate. They aren’t. For instance, it is much cheaper to get loads of square footage by having multiple floors than it is to build one really big ranch. The devil is in the details and, if you aren’t careful, you can end up with tons of square feet in a crowded house when what you really wanted was a broad, quiet expanse of land. The same is true with ETFs — you need to understand the goals within a portfolio to avoid risk of overexposure in an area you hadn’t intended.