ETFs can be a good place to start your investing career, especially for a smaller portfolio, or for a RESP for your child. But watch out—there are both good and bad ETFs.

We still feel that investors will profit the most with a well-balanced portfolio of high-quality individual stocks, but ETFs can also play a role in some portfolios.

Learning how to get into investing with products that focus on lower fees is important. For instance, the MER (Management Expense Ratio) is generally much lower on ETFs than on conventional mutual funds. That’s because most ETFs take a much simpler approach to investment. Instead of actively managing their stock holdings like mutual funds, they generally try to invest so as to mirror the holdings and performance of a particular stock-market index.

ETF fans refer to this as “passive” fund management, in contrast to the “active” management that conventional mutual funds provide at much a higher cost.

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Traditional ETFs follow the lead of whoever sponsors the index, although the sponsors do from time to time change the stocks that make up the index. They also can tinker with the rules for calculating the index. ETFs change their portfolio holdings to reflect these changes, without considering any impact the changes may have on the performance of the ETF portfolio.

How to get into investing with ETFs: For the best results, focus on traditional ETFs

This traditional, passive style also keeps turnover very low, and that in turn keeps trading costs for your ETF investment down.

We think simple is better.

The easier an investment is to explain and understand, the less likely it is to harbour hidden risks and costs that can only work against you. As the old investor saying goes, “Stick with plain vanilla.”

Many “new” ETFs focus on narrower indexes and higher-risk strategies, instead of giving you a low-cost way to copy the results of a standard market index. They also may use a conventional stock-market index as a base, but add their own refinements. This refinement usually aims to appeal to current investor preferences or fads. It distinguishes the new ETF from the older, plain-vanilla variety that simply aims to mimic the index. It may attract attention in a crowded ETF field. If nothing else, it will justify a higher fee than traditional rock-bottom ETF MERs.

In some cases, the new ETF improvement may provide an investment benefit, but it won’t do so consistently. Or it may hurt results, in the long run if not in the short. The worst cases are bad enough to turn investor profits into losses. One sure result is that the higher MER will cut into the value of your ETF’s investment portfolio every year.

Six considerations to make while learning how to get into investing with ETFs

1. Consider buying ETFs in a lump sum rather than periodic small amounts to cut down on brokerage fees.
2. ETFs can be volatile, even with the diversification they offer.
3. Know how broad the fund is, so you can determine its volatility. The broader the ETF, the less volatility it may have. A sector-based ETF like one that tracks resource stocks may be more volatile.
4. Know the economic stability of countries when investing in international ETFs. It’s also good to mention that foreign leaders may not be your ally when it comes to passing legislation that can affect your investments
5. Know the liquidity of ETFs you invest in.

More on why we stay out of certain ETFs

We stay out of ETFs that use leverage (debt), those that aim to pursue some sort of market theory and also those that invest in a narrow market segment, or theme.

We’ve found that our exclusionary rules leave us plenty of scope for sound investing, with lots of high-value opportunities and few surprises. In investment innovations, surprises tend to be unpleasant. That’s because innovations aim at selling more “product” (as brokers say) to investors, rather than raising investor returns. In fact, innovations may give you greater stability, steady income or tax deferral, but you generally pay for these advantages out of total investment return.

How to get into investing with ETFs for a broader scope in foreign investments

We think one of the best ways to invest in foreign (non-U.S.) markets is through exchange traded funds (ETFs). You could add some of these ETFs in reasonable quantities: perhaps 10% of your holdings if you’re a conservative investor (including 5% or so in higher-risk funds, such as emerging market ETFs).

We don’t include in our recommendations any ETFs that are hedged against movements of the U.S. dollar or other foreign currencies against the Canadian dollar. The value of these hedged ETFs rises and falls solely with the stocks in their portfolios, so they would not give you exposure to the U.S. dollar or other foreign currencies. However, we feel that unhedged ETFs can give you valuable diversification.

The diversity of ETFs has increased dramatically over the last couple of years. How much has that wider selection increased your interest in ETF investing?