You will have better opportunities for success with ETF investing when you follow our tips

In 1990, ETF investing was introduced in Canada. The fund was called Toronto Index Participation Shares, and started trading on the Toronto Stock Exchange (TSX). The shares, which tracked the TSE 35 index and later the TSE 100 index, became very popular. It was this popularity that was the catalyst for U.S.-based markets to allow index funds. By the way, it wasn’t until 1993 that the U.S. Security and Exchange Commission allowed the sale of ETFs by U.S. exchanges.

Despite their early introduction, it wasn’t until the last decade that ETFs caught the attention of the investment market. If it wasn’t for the popularity of index mutual funds and other index based investments, we might have missed the evolution of exchange traded funds.

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ETF investing tip #1: Avoid “new” ETFs by sticking with “traditional” ETFs

Some new ETFs use a conventional stock-market index as a base, but then add their own refinements. These refinements are tailored to current investor preferences or prejudices. That’s distinctly different from the traditional ETF, which simply aims to mimic an index. These newer, theme varieties may attract attention—and sales—but they frequently carry higher MERs.

In some cases, the new ETF may provide investment benefits but not consistently. In fact, it may hurt results, in the long run. The worst cases are bad enough to turn investor profits into losses. One sure result is that the higher MERs will cut into the value of your ETF portfolio every year.

Another drawback to the newer ETFs is how much easier it is for investors to act on an urge to invest in a specific stock or stock group without doing any messy and time-consuming—but necessary—research.

ETF investing tip #2: Stay away from leveraged ETFs

Leveraged ETFs aim to offer a two-for-one leveraged bet on the direction of oil prices and other commodity or index prices.

As a general rule, we advise against investing in leveraged ETFs, or anything that requires successful market timing. That includes short selling, options trading, or short term trading of any sort. In all of these activities, it’s a rare investor who makes enough profit to compensate for the risk involved. That’s why we don’t suggest investing in this or any leveraged ETF.

ETF investing tip #3: Pay lower Management Expense Ratios (MERs) by buying ETFs

The MER is generally much lower on ETFs than on conventional mutual funds. That’s because most ETFs take a much simpler approach to investing. Instead of actively managing clients’ investments, ETF providers invest so as to mirror the holdings and performance of a particular stock-market index.

ETF investing tip #4: Stay away from stop-loss orders

Market setbacks always revive investor interest in the stop-loss order—“stop” for short. A stop is an order to sell a stock if it falls to a price you choose. You can apply stops to ETFs as well as stocks.

On average, up to a third of your stocks drop after you buy, just from random fluctuations. Using stops will force you out of any stock that puts on a temporary dip.

In deciding when to sell, it pays to consider all available information, not just price fluctuations.

It’s extremely rare to meet investors who have improved on their investment results over long periods by using stops or any fixed rules on selling. These rules just ensure that you’ll do a lot of buying and selling and spend lots of money on brokerage commissions.

ETF investing tip #5: Avoid using “hedged” ETFs

Consider a typical ETF that gives you exposure to movements in an index of stock prices in an emerging market. This may appeal to investors who are thinking of investing in ETFs or other stocks in that market. But conservative investors may hesitate to buy, because they worry about currency movements in the emerging market. So the financial industry has come up with “hedged” ETFs.

The sales pitch is that you can profit from growth in the stock market of the emerging economy, but you avoid foreign-exchange risk because the ETF operator hedges against it. This conveniently overlooks the fact that hedging costs money.

Hedging costs will vary, depending on conditions in the foreign-exchange market, and on how an ETF carries out its hedging program. These fees can double or triple the typical 0.30% to 0.70% ETF management fee.

You’ll need to dig deep to find out how much you pay for an ETF’s hedging feature. But you can be sure that the placing of each new hedge provides a profit opportunity for the ETF sponsor.

How has the simplicity of ETF investing helped or hurt your returns? Share your story with us in the comments.