When you use an exchange traded fund (ETF) for investing, you’ve made a wise decision. On the other hand, though, there are some pitfalls every investor should be careful to avoid.
Most of these pitfalls can be avoided by doing proper research before you buy. The major faux pas when buying an ETF include not understanding what the fund is based upon and not paying attention to brokerage costs.
- Double coverage: When you don’t pay attention to the holdings in an ETF, you may be investing in the same companies-twice. Be aware of the companies the fund holds. Also be aware of the title of the ETF and how it matches the holdings. A pure-play on a sector is not always what it appears to be.
- An ETF that isn’t: An exchange traded fund (ETF) often gets jumbled around with a closed-end fund (CEF) and an exchange traded note (ETN). Fortunately, it only takes a quick look at an ETF’s description to see what it’s all about. This can be found on the provider’s website. Although this may sound like overkill, it’s easy to do and it’s a necessary step because there can be risks or tax events you may not be aware of.
- Trading costs: Beware of brokerage commissions! If the perfect ETF is costing more than half of the principal, then you get the meaning. Be sure that the fees do not eat into your principal too much, otherwise, why invest?
- Have a plan: This goes for any investment – not just ETFs. When you’re looking at an ETF, what’s your buy point? At what point do you sell? Know the answers to these questions before you proceed, and you’ll find yourself free from emotions as you make necessary decisions. Read more about having a strategy in our new book, The ETF Trend Following Playbook.
For more stories about ETFs, 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.