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ETFs: 2 to Buy, 1 to Avoid

By Dan Caplinger - Oct 12, 2015 at 8:00AM

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Hundreds of exchange-traded funds vie for attention, but you shouldn't randomly pick just any ETF for your portfolio.

Exchange-traded funds have taken the investing world by storm, and hundreds of ETFs are available for investors to add to their portfolios. Yet given the recent volatility in the financial markets, it's more important than ever to be careful about choosing the right ETF for you. With that in mind, let's take a look at three ETFs that many investors are paying attention to right now and identify which ones might deserve a closer look.

All clear for the stock market?
When it comes to broad-based ETFs, none can match the history of the SPDR S&P 500 ETF (SPY 3.18%). This pioneering fund still has the greatest trading volume of any ETF in the market, and it has a longer track record in its S&P 500-tracking prowess than any other exchange-traded fund.

The stock market has finally delivered a long-awaited correction for investors to consider, and although there are still challenges that the market faces, some believe that a favorable U.S. economy should keep the S&P 500 moving higher. With the SPDR ETF typically moving in lockstep with the index, investors can benefit from cheap expenses that amount to just 0.09% annually, and the ETF should deliver typical market returns for long-term investors for decades to come.

Feeling more energetic
If you want to focus in on a particular sector of the market, one place that many value investors are combing through these days is energy. Figuring out which company will be the biggest beneficiary from a rebound in oil and natural gas prices can be tough, but the Select Sector SPDR Energy ETF (XLE 1.32%) offers a chance to capitalize on the health of the entire energy sector.

With a market-cap focus, the SPDR Energy ETF has a considerable concentration in the integrated major oil companies. Yet you'll also find oil-services providers, pipeline businesses, refining operations, and natural-gas focused companies within the ETF. Plunging crude oil prices have produced extremely ugly returns for the energy ETF, but even if oil only manages to stabilize at current levels, it could be enough to make investors bid up shares of the stocks that the ETF holds. That in turn should reward ETF buyers who can handle the risk of owning energy right now.

Be careful with volatility
One big winner in recent years has been the VelocityShares Daily Inverse VIX ETN (NYSEMKT: XIV), which tracks most popular measure of market volatility, the CBOE Volatility Index. Specifically, the VelocityShares ETN is designed to go down when volatility goes up, and vice versa.

For years, quiet markets led to steady and impressive returns for the Inverse VIX ETN, but the recent turbulence has shown how vulnerable the exchange-traded instrument is to abrupt market movements. The VelocityShares ETN lost more than half its value from mid-August to early September during the worst of the market's downward move, and even with stocks having rebounded, the ETN hasn't come closer to regaining its former level. The nature of this investment is that after a big loss, it can take a long time for investors to get back to even -- and continued bounciness in the market could lead to even further losses for ETN shareholders.

Nearly countless choices exist for ETF investors to consider, but it still pays to be discriminating. By looking at low-cost alternatives that give you a favorable risk-reward ratio, you can make the most of ETF investing opportunities and boost your chances of coming out ahead in the long run.

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Stocks Mentioned

SPDR S&P 500 ETF Trust Stock Quote
SPDR S&P 500 ETF Trust
$390.08 (3.18%) $12.02
The Select Sector SPDR Trust - The Energy Select Sector SPDR Fund Stock Quote
The Select Sector SPDR Trust - The Energy Select Sector SPDR Fund
$71.59 (1.32%) $0.93

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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