Exchange traded funds, commonly known as ETFs, have become increasingly popular among financial advisors and investors due to their low-cost nature. ETFs offer a convenient way to gain exposure to a diverse range of stocks and bonds. If you’re interested in buying ETFs but don’t know where to start, this guide is for you.
Step 1: Open a Brokerage Account
To begin your journey into ETF investing, the first step is to open a brokerage account. However, before you make a decision, take some time to consider your goals. Different types of accounts cater to different objectives.
What To Look For In A Broker
Besides the various account types offered by major brokerages, there are other factors to consider when choosing a brokerage:
- Fees: Pay attention to trading fees and maintenance charges. Many brokers now offer fee-free trading, which is particularly important since ETFs are traded like stocks.
- Minimum deposit: Some brokers require a minimum deposit to open an account. Fortunately, for ETFs, the minimum is usually the cost of one share. Look for brokerages with affordable minimums or no minimum at all.
- Types of assets: Not all brokers allow you to purchase all types of investments, and even if they do, not all may offer fee-free trading. If you plan on using ETFs in your portfolio while also diversifying your investments, double-check that your chosen broker supports your desired assets.
- Customer service: Consider the level of support offered and how responsive the brokerage is.
- Special features: Look for additional features that align with your financial goals. For example, automatic tax-loss harvesting or portfolio rebalancing may be important to you. Ensure that the brokerage you choose offers these features if they are important to your investment strategy.
If you prefer a hands-off approach to investing and want to avoid the stress of selecting individual ETFs or handling routine maintenance, consider using a robo-advisor. Robo-advisors construct low-cost, diversified portfolios of ETFs and provide automated portfolio rebalancing to help you stay on track. However, keep in mind that robo-advisors typically charge a management fee, usually around 0.25% of your invested amount. If you’re comfortable managing your portfolio yourself, many brokers offer DIY options at a lower cost.
Step 2: Decide on Your ETF Investment Strategy
Once you have a brokerage account, it’s time to determine your ETF investment strategy. This involves deciding on your asset allocation, or the percentage of your portfolio dedicated to different types of investment securities. Typically, a balanced approach involves allocating your investment dollars between conservative bond ETFs and aggressive stock ETFs.
Bond ETFs offer stability in value but may provide more modest returns. On the other hand, stock ETFs have greater growth potential but come with larger short-term fluctuations in value. Your investment timeline should guide your asset allocation decisions. The further away your goal, the more time you have to recover from short-term stock ETF dips. Conversely, if your goal is near, you may want to prioritize the stability offered by bond ETFs.
Considering your risk tolerance is also crucial. If you are unwilling to take on much risk, even for long-term goals, a more conservative approach may be suitable. Keep in mind that investing conservatively may require contributing more of your own money to reach your goals, as you would rely less on investment gains.
Step 3: Research Your ETFs
With your ETF asset allocation in mind, it’s time to research the ETFs that align with your goals. Most brokerages offer ETF research tools that allow you to screen for specific indexes or strategies. Third-party databases like ETFdb.com can also provide valuable information.
Here are a few key considerations when researching ETFs:
Index
Nearly all ETFs aim to replicate the performance of specific indexes. Choose indexes that reflect your desired asset allocation. Stock-based indexes such as the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are good starting points for the stock component of your portfolio. If you’re interested in specific sectors, consider indexes that track segments of the market such as large-cap, mid-cap, small-cap companies, or international/emerging markets stocks. Keep in mind that while these indexes may carry more risk, they may also offer higher returns.
Fees
ETFs typically have lower fees compared to actively managed funds since they passively track an index. Nonetheless, it’s important to pay attention to expense ratios. Different providers may offer ETFs with varying expense ratios. Opt for ETFs with the lowest operating fees, as the performance of ETFs tracking the same index tends to be similar regardless of cost. Additionally, ensure that your chosen brokerage allows fee-free trading of the ETFs you select.
Step 4: Buy the ETFs
If you’ve decided to manage your portfolio independently without a robo-advisor, you’ll need to select and purchase your chosen ETFs. The process is similar to buying stocks.
- Fund your account: Transfer cash into your brokerage account to have the necessary funds to buy ETF shares.
- Search for the ETF ticker symbol: Use your brokerage’s research tools to purchase shares directly from the ETF’s entry if available. If not, navigate to the trade section of your brokerage and enter the ticker symbol.
- Enter the number of shares you want to buy: Indicate the quantity of shares you wish to purchase. Some brokers may display the maximum number of shares affordable based on your available funds. Keep in mind that ETFs usually cannot be bought in fractional shares. As a result, you may not be able to invest the entire amount of money you have ready to invest at once. Some funds may have to wait until you accumulate enough for another full share.
- Confirm the order: Review and confirm your purchase. In most cases, a “market order” is the default option, indicating that your purchase request will go through at the current price of the ETF instead of waiting for a specific price.
Step 5: Set Up Your Purchase Plan
Buying ETFs is often an ongoing process rather than a one-time event. Establishing a purchase plan can help you reach your investing goals over time. Most brokerages offer the option to set up recurring purchases.
Arrange for a predetermined amount of money to be regularly transferred from your checking account to your investment account. Then, instruct your brokerage to use the transferred funds to purchase as many shares as possible. This strategy, known as rupee-cost averaging, can potentially lower your average cost per share over time.
As you set up your ETF purchase plan, consider how frequently you will review your portfolio. Experts generally recommend checking your investments every six to 12 months to ensure your asset allocation remains aligned with your goals. If your holdings have deviated significantly, you may need to buy or sell certain investments to bring your portfolio back to your desired level of risk. While this process isn’t complex or time-consuming, if you prefer a more hands-off approach, a robo-advisor can automatically handle this for you.
Step 6: Decide on Your Exit Strategy
Eventually, you’ll want to sell your ETF shares. Planning your exit strategy in advance can help minimize capital gains taxes and optimize your profits. Consider strategies such as tax-loss harvesting and strategic withdrawals from tax-advantaged retirement accounts to minimize tax liabilities. Consulting a financial advisor can assist you in determining the most efficient approach.
Investing in ETFs can be an excellent way to build a diversified portfolio and achieve your financial goals. By following these steps and conducting thorough research, you’ll be on your way to becoming a successful ETF investor. Happy investing!
