Like any investment, it’s prudent to have a strategy in place before you fork over
your cash to an ETF fund manager. Here are several important questions to consider before starting:
1. What’s your budget and investment horizon? You can use ETFs for any level of activity, from day trading to long-term buy and hold. Day-traders who don’t want to pick individual stocks can use ETFs to bet on index movements. Because ETFs trade as stocks, you can assign stop losses to limit your risk. You can also short
ETF shares if you expect an index to decline. See below to learn more about leveraged and inverse ETFs. As with all day trading, you must
ensure you don’t violate free-riding regulations that prohibit you from
selling securities you haven’t paid for. If you instead want to benefit
from long-term trends, you can invest money that you won’t need to
access for at least five years, and probably a lot longer. It’s unrealistic
to adopt a long-term strategy with money you’ll need in the next few years.
2. What’s your appropriate asset allocation? ETFs provide instant diversification, but not instant asset allocation – the percentages of your investments devoted to stocks, bonds and other assets. It’s common wisdom, to the point of cliché, to concentrate on stocks when you’re younger and slowly switch to bonds as you age. While this advice has merit, you must apply your unique circumstances to your asset allocation decisions. For example, if you descend from long-lived ancestors, you might want to remain in stocks well into your 80s. Don’t neglect other assets such as precious metals and commodities to round out your ETF selections and give you the widest diversification.
3. Do you need a full-service broker? Probably not, unless you feel intimidated about investing on your own. You can save money by using a discount broker and investing in the lowest-cost index ETFs. Depending on how much you invest, you can save hundreds of dollars a year by choosing the lowest cost ETFs that meet your requirements. Watch out for short-term redemption fees and other hidden costs.
4. Can you stick with your strategy? It’s no use to adopt a long-term strategy if you panic each time the market declines. It’s also unrealistic to day trade if you can’t closely monitor markets during the trading day. In general, you’ll want to stick to your strategy or, if you have good reason, adopt a new one.
Once you’ve decided on a strategy, you can open an online brokerage account quickly and fund it through a transfer from your bank or by writing a check.
Your broker will likely offer you a margin account, which allows you to
borrow up to half the money you need to purchase securities. If you are new to
trading, you might want to postpone using a margin account until you are
comfortable with cash trading. Many brokers offer sophisticated online platforms for frequent traders. These platforms provide a wealth ofinformation and allow you to craft complex trades. For example, you might want to buy shares of a certain ETF only when its price rises above its 50-day moving average. Once again, you can start simply and work up to the more sophisticated trading techniques.
However, it’s useful to learn about limits and stops before you begin trading, as these can provide important safety features. Just about all brokers offer online education that will teach you how to place trades with limits and stops.