{"id":15703,"date":"2022-04-27T14:32:17","date_gmt":"2022-04-27T21:32:17","guid":{"rendered":"https:\/\/www.wealthfront.com/blog\/?p=15703"},"modified":"2026-04-15T16:52:45","modified_gmt":"2026-04-15T23:52:45","slug":"how-should-i-evaluate-an-etf","status":"publish","type":"post","link":"https:\/\/www.wealthfront.com/blog\/how-should-i-evaluate-an-etf\/","title":{"rendered":"How Should I Evaluate an ETF?"},"content":{"rendered":"\n

Exchange-traded funds<\/a> (or ETFs) are a popular way to invest, and for good reason. They hold collections of investments like stocks or bonds, and are a convenient, tax-efficient way to build a diversified portfolio. The vast majority of ETFs passively track indexes, meaning they try to match the return of the index (rather than outperform it, which usually doesn\u2019t work in the long run<\/a>). There\u2019s a broad universe of ETFs you can use to build a portfolio, but with so many choices (many of which are quite similar), you might not feel confident in your ability to choose the right ones. <\/p>\n\n\n\n

Here, we\u2019ll explain how Wealthfront\u2019s investment research team thinks about choosing passive ETFs for our recommended portfolios so you can apply the same thinking to your own portfolio should you wish to do it yourself. For the purposes of this post, we\u2019ll assume you already have an investing strategy in mind and just need help picking a passive ETF for the job of representing each asset class you want to include.<\/p>\n\n\n\n

Expense ratio<\/h2>\n\n\n\n

An ETF\u2019s expense ratio<\/a> is the fee charged by the ETF\u2019s issuers to manage and operate the fund. It\u2019s an annual fee expressed as a percentage of the ETF\u2019s assets. It should be a primary consideration when you\u2019re evaluating a new ETF because fees eat into your return. The lower the expense ratio, the more return you get to keep. You can find the expense ratio for any ETF offered at Wealthfront by searching for it here<\/a>. <\/p>\n\n\n\n

Many ETFs are quite similar\u2014they might give you exposure to the same sector or even track the same index. In some cases, two ETFs will be basically identical except for the fees you\u2019ll pay to own them. All other things being equal, it\u2019s smart to choose the ETF with the lower expense ratio. Passive ETFs cost around 0.20%<\/a> on average. <\/p>\n\n\n\n

Liquidity<\/h2>\n\n\n\n

An ETF\u2019s liquidity refers to how easy it is to sell your investment when you want to cash out. If an ETF has a high trading volume (lots of people are buying and selling it) it\u2019s pretty liquid. But if it has a low trading volume, it could be hard to sell and thus less liquid. <\/p>\n\n\n\n

In practice, liquidity affects the cost to buy and sell an ETF. When an ETF is less liquid, it can trade with a larger bid\/ask spread<\/a>. If you\u2019re a long-term investor and plan to hold an ETF for years, this probably won\u2019t have much impact on your bottom line. But if you plan to buy and sell investments frequently, these costs can add up. All other things being equal, you\u2019ll want to choose an ETF with a higher trading volume and thus a lower bid-ask spread.
You can also calculate the total cost to own a fund by doubling its bid\/ask spread (find this on etf.com<\/a>) and scaling the expense ratio to your expected holding period (a calculator like this one<\/a> can help). Adding those two numbers together will give you a good sense of what owning the fund will cost you.<\/p>\n\n\n\n

Securities lending<\/h2>\n\n\n\n

You should also know that many ETF issuers make money by lending out the underlying securities to hedge funds to enable short sales. The more securities lending an ETF issuer engages in, the more risk to you if you buy the ETF. That risk is mostly associated with how the cash collateral for the securities gets reinvested by the lender\u2014it can lose value and become a loss for the fund. An ETF\u2019s prospectus will often tell you whether or not a particular fund participates in securities lending. Whenever possible, we think it makes sense to choose an ETF that minimizes securities lending or shares the revenue from securities lending with you. <\/p>\n\n\n\n

Tracking error<\/h2>\n\n\n\n

Passive ETFs are designed to track an index like the S&P 500 or the NASDAQ 100, to name a few well-known examples. The goal of these index-based ETFs is to provide a return that\u2019s as close as possible to the return of the index. Tracking error tells you if the ETF is succeeding at that goal\u2014lower is better. Here are several factors that can cause tracking error:<\/p>\n\n\n\n