Exchange traded fund(ETF) investing and trading is an effective way to gain diversified exposure to sectors without the risk of trying to pick single stocks. There are ways to make this process as seamless and foolhardy as possible.
Eric Tyson for The Houston Chronicle spoke to investment managers Litman and Gregory, publishers of the newsletter, No-Load Fund Analyst, who came up with these guidelines that make ETF trading easier.
Remember that an ETF with high trading volume means that is has more liquidity. ETF providers agree that around $100 million in assets is necessary for a company to justify trading an ETF. This helps investors avoid investing in a product that could be at risk for closure.
Other points of note:
- Check the bid-ask spread. The bid-ask spread is the difference between the highest price a buyer is willing to pay for an asset and the lowest price at which a seller is willing to sell that same asset. As liquidity increases for a particular product, the spread will narrow, and a smaller spread is a reflection of a good product.
- Spreads can vary across asset classes. For example, ETFs that track the S&P 500 should have low spreads, because of the liquidity within those funds. Some foreign securities, such as emerging markets, may have a wider spread.
- Look at the NAV. That is, the net asset value. Is the fund trading at a premium or discount in comparison? Compare this between a few funds in the same sector or asset class.
- Timing matters. Try to trade an ETF when the markets for the underlying stocks are open, for example, when international markets are open. Do not trade at opening bell or when it’s just about closing time, as the daily spreads have not yet been established.
- Limit orders vs. market orders. Use limit orders when executing trades. When using a market order, you don’t have any control of the price you’re paying. Entering a limit order (that is, entering a “limit” or a maximum price you’ll accept) will help remedy this situation.
For more stories about ETF education, visit our ETF 101 category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.