Buy Exchange Traded Funds
A relatively new financial product called an exchange-traded fund (ETF) gives investors access to excellent diversification and liquidity. At the same time it combines some of the advantages of both mutual funds and individual stocks. An ETF looks like a mutual fund and behaves like a stock on an exchange. These funds have a number of additional characteristics that investors should know about. Here are some of the basic steps involved in a plan to buy exchange-traded funds, as suggested by various professionals who understand the ETF's usefulness in a modern investment portfolio.
Steps
- Open a brokerage account. Like stocks, ETFs are not available to individual investors directly, which is why those who want to buy in to these tradeable funds do so through brokers (including mutual funds acting as brokers). Many investors simply call their broker and place their trades over the phone. Many others, including most beginners, use online brokerage accounts. Such accounts are generally easy to use and provide the documentation crucial for trades. When you open your brokerage account, be sure to review the terms of use.
- Understand commission structures. Typically your broker is going to want a certain amount of money in order to help you buy and sell an ETF. This commission comes directly out of your brokerage account with each trade. Many times it is factored in to the cost of the purchase or the proceeds of a sale. One of the first key steps in evaluating your brokerage is to make sure you are not paying too much for these services. To avoid overpaying commissions, compare the services of your broker to others within a specialized financial field. Ask around and look for the lowest commissions offered by competitors.
- Many mutual fund companies will sell you shares in their ETFs while charging relatively small commissions. The Vanguard Group, for instance (one of the world's largest mutual fund companies), charges no commissions at all in selling ETF shares. They make their money in part by assessing "expense ratios," and theirs are among the lowest in the industry. You can verify this by visiting an independent research site such as Morningstar or Lipper.
- Research different ETF options. Do some homework before selecting ETFs to buy so that you are well informed about the financial products with which you are dealing. The most direct way to research ETFs is to review the menus of ETF options offered by the top ETF providers in your region. You can do this online or by ordering prospectuses over the phone.
- Research ETFs by type. There are ETFs dedicated to real estate, commodities or any number of other financial sectors. Learn the history of any ETF regarding its record of gains and losses over time. Short-term results (months or even a year or two) should not be considered as significant as longer-term results (five, ten, or more years). Bear in mind that many ETFs are relatively recent start-ups and may not have much history to report.
- See how an ETF is managed and if it is leveraged. Different management styles will employ different strategies and yield different returns.
- Check up on fees and expenses. ETFs feature something that stocks do not: maintenance costs. Other than brokerage commissions, stocks don't have fees or other expenses. In contrast, ETFs, like mutual funds, do charge fees to cover management and overhead expenses. ETFs may charge fees when you buy shares and/or when you sell them. Make yourself aware of all such costs and how they are to be paid before you commit any money.
- Place trades. When you know which ETF(s) you want to buy, you can purchase shares through your broker either online or by phone.
- Keep good records. After you invest, your work is not done. Record all cost-basis numbers for future tax returns. Most importantly, monitor your shares closely so that you will recognize good buying and selling opportunities.
- Record all purchase and selling prices for your own analysis. If your brokerage does not provide you with a good visual representation of all your trades, keep your own detailed records in order to select appropriate sell points with respect to capital gains. An Excel spreadsheet can be a simple and effective way to keep track of trade values.
- Hold on to your annual tax records. Many pros suggest keeping all of the trade values, cost basis and similar ETF trade data for at least seven years in order to provide these details to tax authorities if it should become necessary. One suggestion is to scan documents into a computer in order to keep backup files in a digital form.
Tips
- One of the advantages of owning ETFs for traders who like to be proactive in managing their portfolios is that ETFs (like stocks) are priced on a moment-to-moment basis as dictated by market forces during the trading day. This distinguishes ETFs from mutual funds, whose share prices reset once at the end of each trading day. For beginning investors this may not be an important distinction.
- Before committing money to ETFs (or any other plan, for that matter) consider consulting with a certified, fee-only financial advisor. Speak with a "fiduciary" advisor, one who is by law required to put your best interests ahead of his/her own. In contrast, a commission-based advisor stands to gain simply by convincing you to buy some financial product, regardless of how appropriate it may be for you.
