Tuesday, October 6, 2009

10 Tips When Buying ETF Index Funds

Morningstar had an interesting article a couple of month back that discussed 10 tips to make your ETF trades more effective. As a dividend investor who uses index funds to build our his core portfolio, I found this article interesting. Not because I feel that I should implement each of these tips, but because I don't necessarily agree with all of them. Here are the tips with some of my comments.

1. Avoid placing orders near the open and close

When I do buy ETFs, I do follow this rule. At the beginning and end of the day there can be some really funky market action which means you can pay more for your shares than you should. Over the long-term is probably averages out and does not impact your performance too much, but it does not hurt to simply buy or sell in the middle of the day.

2. Use caution during volatile days

This one makes sense in the same way #1 does, but I don't worry about this one too much. Again, over the long-term it probably does not matter too much but probably worth thinking about.

3. Use limit orders for best execution

I do not use this one simply because when I buy ETFs for my account they are with the long-term in mind and I never have a specific ETF price in mind. I will more than likely buy shares of a particular ETF many times. If you are a short-term holder of an ETF then perhaps limit orders make sense. However, as a long-term buyer I do not do this one.

4. Select ETFs with good liquidity

I do not buy ETFs that are focused on niche areas of the market. Instead I buy big, broadly based index funds. Therefore, the funds I am focused on tend to have high liquidity. My advice to people who ask is to not get too niche in their portfolios and stick to big market areas such as growth and value. If you do this, then liquidity will not be an issue.

5. Trade while the underlying market is open

I do not buy after hours. I also do not buy index ETFs focused on specific geographic markets. As such, I do not worry about this one and probably never will.

6. Consider using a stop-loss order

I am a long-term investor and not a trader. I also understand that markets can do up and down dramatically, but tends to always head upwards over long periods of time. Therefore, I tend to just let my ETFs float along with the markets and do not set lower limits. There is a lot of conflicting view points on this, but I do not set stop-losses.

7. Pay attention to transaction costs

Yes, Yes, Yes, Yes, Yes, Yes, Yes,!!! This is important. Make sure you have the lowest cost broker you can get. They provide a commodity and most of the time there is no reason to pay higher commissions.

8. Be careful when using leveraged ETFs

Do not use these things. They are intended for short-term traders and not for long term buying and holding. I do not use them.

9. Consider the number of market makers

What the heck does this even mean? Ignore it.

10. Be mindful of the distribution date

If you hold your ETFs in a taxable account, then this is important. The last thing you want to do is buy an ETF in December and get stuck with a tax bill for the whole year.

Overall, some interesting suggestions. Some of them are important for long term dividend investors like us. Others are worth ignoring and doing nothing with them.

This article was written by The Dividend Guy. You may email questions or comments to me at info@thedividendguyblog.com.

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