Choosing a High-Performing Index ETF

When you want to choose a high performing index ETF, there are several important decisions to make. You need to decide if you are comfortable using leverage-–an increasing number of ETF providers offer this option. You need to determine if there is an investment bias you wish to take or if a broader approach is more in keeping with your risk tolerance. Finally, you need to choose the most appropriate provider for your needs; many offer very similar products.

General Considerations

As with any investment decision, you should determine your time horizon, risk tolerance, and objectives prior to deploying any capital. If you have a high level of risk aversion, for example, leverage is less likely to be appropriate. These are the most basic investment considerations, but can significantly simplify the process, as certain choices will be easily eliminated by answering these questions.

Leverage

A leveraged ETF is designed to magnify the return of its underlying index, usually by a factor of 2 or 3. Therefore, if you own a leveraged ETF on the S&P 500 on a day the index rises by 1 percent, your return will be 2 or 3 percent. There are also ETFs that move in the opposite direction of the underlying index. The drawback of leveraged ETFs is that over time they tend to lose value regardless of the performance of the index they track. For this reason, they are appropriate for trading, but tend not to make good long-term investments. If your intention is to actively trade the index ETFs you select, leveraged ones may be appropriate as they can generate out-sized returns.

Choosing an Index

In most cases, when you want to choose a high performing ETF, the central question is which index to invest in. Some indexes, like the Russell 2000, will give you exposure to smaller cap stocks that may perform better when the market is rising. The theory here is that during an economic expansion, smaller companies tend to be more growth-oriented and more able to capture returns. While large companies have matured in the marketplace, small companies are more nimble and able to capitalize on fresh opportunities. In contrast, during more challenging periods, larger companies are thought to be more able to weather the storm. Broader indexes like the S&P 500 may be more stable and appealing to you if you prefer less risk.

Just as the Russell is a broad market index that focuses on a different market segment, there are indexes that track different sectors of the market. Ranging from energy to technology to financials, you can invest directly into a specific sector of the economy. One popular strategy is to determine which sector has been lagging and invest for a turnaround. This would have been a very successful approach in financials after the recent crisis, as only a few institutions failed and the sector experienced explosive growth. No matter the specific approach, the most important step in choosing a high-performing index ETF is to determine your own needs and then tailor any decisions to those needs.

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