Exchange traded funds (ETFs) have grown in popularity over the past two decades and, for most investors, now represent the default method for index investing. To begin investing in ETFs, investors will need a trading account, funds to invest, and some knowledge of what ETFs match their investing goals.
How To Invest In an ETF: 4 Easy Steps
Step 1: Open a Trading Account
Before investing in an ETF, an investor will need a trading account, such as an individual brokerage account, joint brokerage account, a minor account, or anindividual retirement account (IRA). The type of trading account needed to invest in an ETF will depend upon a few preferences, such as trading style and savings goals.
Types of trading accounts are:
- Individual brokerage account: Registered in the name of only one account owner. Capital gains, dividends and interest are taxable. Investors can open a cash account or margin account.
- Joint brokerage account: Commonly held by spouses, the account is shared by two or more individuals. Capital gains, dividends and interest are taxable. Investors can open a cash account or margin account.
- UGMA/UTMA minor account: Custodial account controlled by a parent or other adult relative. Account assets are held in the name of the minor until the child reaches the age of majority, which varies by state. Gains are taxed at the minor's marginal tax rate, which is often zero if they have little or no income.
- Individual retirement account (IRA): There are 2 types of IRAs: Traditional IRA and Roth IRA. Both must be registered in the name of one individual account owner. Contributions to Traditional IRAs are tax deductible but the investor must pay taxes at the time of withdrawal. For Roth IRAs, there are no tax deductions available at the time of contribution, but withdrawals are tax free.
Step 2: Research & Compare ETFs
To find and analyze ETFs, investors can use an online tool, such as Seeking Alpha's ETF screener, which can screen for multiple data points, including:
Investors may also find ETF research online at their brokerage firm or with a fund research company.
Tip: Many ETFs are passively managed funds with the goal of tracking the performance of a benchmark index, such as the S&P 500. ETFs that seek to track the same benchmark index are essentially competitors, and many fund companies try to entice investors with lower expense ratios. Funds with low expense ratios may not always outperform those with higher expense ratios, but fee levels should be on investors' radars as they research the options.
Step 3: Place the Trade
Since ETFs trade intra-day like stocks, investors can place a market order and receive the best available transaction price at any time during regular market hours. As an alternative to market orders, investors who would prefer to specify a maximum entry price can place a buy limit order. A buy limit order will only execute if the security price drops to that level.
Aside from brokerage firms who allow for the trading of fractional shares, the minimum initial purchase amount for an ETF is the price of one share. Depending upon the brokerage firm or investment company, buying and selling ETFs may also incur brokerage commissions. These fees tend to range from $7.00 to $10.00 per trade. Some brokerages have instituted zero-commission trading on ETFs.
Step 4: Monitor Your Trade
Once an ETF purchase has been completed, investors may wish to monitor how it is performing. Day traders and short-term investors will typically monitor their holdings very closely, while long-term investors who are less concerned with short-term price fluctuations may be less inclined to constantly assess how their investment is performing.
Exiting the Trade
Investors can establish an exit strategy for their holdings at the time of purchase, or make those decisions later on. Investors who have a set profit objective in mind can set a limit sell order at their take profit level. For instance, an investor who purchases an ETF at $20/share and is targeting a 20% profit can set a limit sell order at the $24 level.
Investors who want to limit their potential losses on an investment can set a stop loss order. For instance, an investor who purchases an ETF at $20/share and is unwilling to accept more than a 20% loss can set a stop loss order at the $16 level.
Many investors prefer to monitor their investment positions instead of specifying preset take-profit or stop-loss levels. When these investors are ready to exit their position, they may place a market order to sell their position.
Keep in mind that investment positions do not have to be divested all at once. An investor who purchases 300 shares of an ETF may wish to take profit on 100 shares, while holding the other 200 shares.
ETF transactions typically "settle" in two days, meaning that the cash proceeds from selling shares of an ETF would be available two business days after the trade.
Tip: Some investors may establish a take profit level and/or stop loss level at the time of the initial investment.
To invest in an ETF, an investor will first need a trading account and funds available to buy shares. Carefully researching the available investment options is prudent, and there are multiple resources for researching and comparing ETFs, including Seeking Alpha's ETF screener. Before buying, investors should establish whether a specific ETF is appropriate for their investment goals and risk tolerance.
This article was written by
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