Having a sound ETF strategy will help you target the best ETFs—and maximize your gains

Unlike many mutual funds, Exchange Traded Funds don’t load you up with heavy management fees, nor do they tie you down with heavy redemption charges if you decide to get out early. Instead, they give you a lower-cost and more flexible and convenient alternative to mutual funds.

Below are some tips for utilizing a sound ETF strategy to build your portfolio with the best ETF options.

ETF strategy: The best ETFs provide the best of both worlds

Investors get the broad market exposure of a traditional mutual fund, plus the ability to trade at will with nominal fees. The best ETFs represent a low-cost, tax-efficient way for investors to make money in the long term.

Investors can buy ETFs via stock exchanges, as well as on margin. They can also sell them short. The best ETFs offer well diversified, tax-efficient portfolios with exceptionally low management fees. Investors large and small can use ETFs to build well-diversified portfolios.

ETFs have evolved, and competition has increased. Still, you need to be very selective with your ETF holdings.

A strong ETF strategy focuses on the best types of ETFs to buy

We think you should stick with “traditional” ETFs. However, when an investment product faces booming demand as ETFs do today, investment companies try to expand sales by creating “new” versions of the underlying formula.

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

In some cases, new ETFs may provide investment benefits but not consistently. In fact, they 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 new ETF 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 research. If you want to invest in oil stocks or gold stocks or Swedish stocks or wind power stocks, or any of hundreds of other stock groups, you can act on that urge. However, that may not produce the best results.

Bonus Tip: If you do invest in mutual funds, you should avoid aggressive growth funds that mainly invest in stocks of companies that hold a lot of concept stocks, or that do a lot of trading, or that delve into options or futures trading.

ETF Strategy: Templeton’s “10 Engineers” Rule is still relevant today

I learned a great deal about investing from reading about Templeton’s career, his investing strategy, and the way he expressed his ideas. One of his recurring themes was what he called his “10 engineers” rule. It goes like this: If you want to build a bridge and you ask 10 engineers how to do it, and they all tell you the same thing, that’s probably a good way to build a bridge.

However, if you ask 10 investors about a particular stock or the market outlook and they all agree, they are probably giving you bad advice. Things are likely to work out differently. When investors generally agree on something, it rarely happens.

I see this rule as relevant today. If you asked 10 investors what they foresee for the market for the next 10 years, most, if not all, would probably agree that we face rising taxes, legislative struggles over where to cut the budget, and weak economic growth. That’s the only outcome they can foresee from today’s enormous government debts and budget deficits.

Of course, I don’t know what is going to happen in the next 10 years. No one does. But I suspect that Templeton’s “10 engineers” rule will hold true, and today’s most popular predictions will vary widely from what actually happens.

Do you agree with Templeton’s rule?