2 free tools I use before investing in ETFs

Let's ditch the boring intro about ETFs and jump straight to the good stuff: free tools that will transform how you pick winning ETFs!

Tool 1: How to find your ETF overlap

Imagine you're shopping for clothes. You wouldn't buy two identical jackets, right? The same goes for ETFs. You want diversification, not redundancy. Here's where the ETF Research Center Fund Overlap Tool comes in.

This tool lets you see which companies two ETFs have in common. Why is this important? Because if two ETFs own mostly the same stocks, you're not spreading your risk – you're basically buying the same jacket twice!

For example, let's look at popular ETFs SPY and QQQ. The tool reveals they share a whopping 88 holdings! It even breaks down the percentages: a significant 87% of QQQ's holdings are also in SPY.

But here's the kicker: what truly matters is the weightage. In my view, anything above 40% overlap is a red flag. It means these ETFs are too similar.

While avoiding nearly identical ETFs, it's also important not to over-diversify. Over-diversification can lead to situations where one ETF rises while the other falls, resulting in no net gain. Over time, this lack of growth can be frustrating.

Tool 2: How to check the ETF relationship

To address this issue, use the second tool: www.etfreplay.com/correlation. This tool helps you check the correlation coefficients, which measure the degree to which the movements of two different ETFs are related. The correlation coefficient ranges from -1.0 to +1.0. A value greater than zero indicates a positive relationship, while a value less than zero indicates a negative relationship.

Using www.etfreplay.com/correlation to analyse SPY and QQQ, you find a correlation coefficient of 0.95, indicating a very strong positive relationship. When SPY moves up, QQQ tends to move up as well.

Investing in two ETFs with a positive correlation is fine. However, avoid investing in ETFs with a negative correlation.

For instance, SPY and SH have a correlation coefficient of -1.0, indicating a perfect negative correlation. This means when SPY increases by $1, SH decreases by $1. Over time, investing in these two will not yield any gains.

Diversify ETFs smartly for maximum gains.

Before you invest in another ETF, use these free tools to understand how they interact. You want diversification, but not to the point where your ETFs become dance partners who never leave each other's side, or worse, bitter rivals constantly pulling you in opposite directions.

By using these tools and finding ETFs that strike the perfect balance, you'll be well on your way to building a robust, profitable ETF portfolio!