ETF Investing Guide: A Quick Checklist

by: David Jackson

Asset allocation and account set-up

  • Before you do anything else, decide on your asset allocation. It will be a function of your age, risk tolerance, projected financial needs, and total assets.
  • Open an online brokerage account with a linked money market bank account. Shop around for the lowest commissions on the brokerage account combined with the highest interest rates on the money market account. Make sure the brokerage you chose tracks individual tax lots. That will be important for tax loss selling later on.
  • Decide whether you want to implement your asset allocation strategy immediately, or wait to purchase some asset classes until the valuations become more attractive to you. (For example: you’ve allocated 30% of your assets to bonds, but you don’t want to buy them when interest rates are likely to rise and bond prices to fall.) If you’re not sure, allocate your assets in line with your plan gradually over a period of time you’re comfortable with, such as a year, two years, or five years.

If you have a “full service” brokerage account

  • Dump your broker. Move your entire account to an online brokerage.
  • Sell all your stocks. Make sure you do this after moving your account (not before), as you’ll pay lower commissions in an online brokerage than a full service brokerage account. If your positions are large or you own illiquid stocks, be sure to use limit orders.
  • If you are happy with current market levels, purchase a basket of ETFs in line with your asset allocation plan.
  • Open an online bank money market account, preferably linked to your brokerage account (for easy transfers). Park any unused cash in the higher-interest bearing money market account rather than the brokerage account.

If you own mutual funds in a taxable account

  • If you own mutual funds in a taxable account with a mutual fund company, or held in a brokerage account - shut down the account and move the contents to an online brokerage.
  • Sell the mutual funds and purchase a basket of ETFs in line with your asset allocation plan.
  • Watch out for mutual funds with back-end loads. Some funds have back-end loads that disappear after a period of time, say six years. In that case, consider holding on to the funds to avoid paying a hefty back-end load, and selling the fund once the fee period expires.

If you have a 401-K account
Most financial firms that administer corporate 401-K plans (retirement savings plans) offer only mutual funds, not ETFs. Given that you are making small and regular contributions to your 401-K, mutual funds are probably more suitable anyway (due to the trading costs of buying ETFs). So much of my advice, particularly about using ETFs to cut costs and ease portfolio management, won’t be actionable. Instead, try to do the following:

  • Make sure your asset allocation plan includes your retirement funds. Most financial advisors recommend that as you age you should cut the proportion of your assets in equities, as they are riskier over shorter periods of time than bonds or cash.
  • If your 401-K offers low cost stock and bond index funds - particularly those offered by Vanguard - switch into those from actively managed funds with higher expense ratios.
  • Dividends and interest are not taxed in a 401-K plan until withdrawal, when they are taxed at your current tax rate. So if you have a retirement account and a regular taxable investment account, it makes sense to hold bond funds in your retirement account and stock funds in the taxable account.

If you leave a job where you had a 401-K

  • If you leave your job, you can transfer your 401-K account to a Rollover IRA (Investment Retirement Account). A Rollover IRA looks just like a regular brokerage account (with restrictions about additions and withdrawals), and most online brokerages offer them.
  • Conversion of a 401-K to a Rollover IRA is a terrific application of the ETF/online brokerage strategy. You can sell your entire 401-K mutual fund holdings in only a few trades, and allocate the assets between ETFs. You’ll immediately cut the annual expenses you pay, and enhance your ability to manage the asset allocation of your portfolio.

Adding closed-end funds

  • Consider allocating a small percentage of your portfolio to emerging markets stocks.
  • Search for closed-end, single-country mutual funds trading at deep discounts to net asset value. You can find web sites that report discounts on The ETF Resource Page.
  • Use these funds to gain exposure to the emerging markets you have selected.

Managing your portfolio

  • Choose a portfolio rebalancing rule (the trigger should be periodical or, better, a percentage deviation from your target asset allocation), and rebalance your total portfolio - including taxable and retirement accounts - in line with the rule you have chosen.
  • Use creative tax loss selling in taxable accounts to reduce the capital gains from rebalancing and perhaps other investments, and to realize deductions against current ordinary income.

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