Continue the ETFs course with module 3 and understand what to consider when investing in ETFs, as well as the buying and selling process.
5 KEY CONSIDERATIONS BEFORE INVESTING IN AN ETF
Before purchasing an ETF there are five factors to take into account 1) performance of the ETF 2) the underlying index of the ETF 3) the ETF’s structure 4) when and how to trade the ETF and 5) the total cost of the ETF.
BREAKING DOWN THE 5 CONSIDERATIONS
1) Measure performance
Performance of an ETF means more than just how much money is gained or lost as the ETF’s underlying index rises and falls. It is refers to how closely the ETF matches the index performance.
Measure how well the ETF tracks the index
While an ETF is closely aligned with the performance of the index it is tracking, they do not match exactly. There are several reasons, for example, the costs involved with managing an ETF can affect its performance.
2) Know the ETF’s index
With a plethora of indexes in the investing universe, how do investors pick? Financial professionals can help investors determine the appropriate index by understanding the investors’ investment objectives and the purpose of the ETF.
In order to determine the role of the ETF in a portfolio, consider the specific examples below as potential uses.
- Access to country-specific, regional, and global assets.
- Exposure to sectors that are areas of interest, such as technology, telecommunications, renewable energy sources or consumer goods.
- Access to specific asset classes, which include equities, fixed income, real estate, commodities, etc.
3) Consider the ETF structure
Two types of ETF structures
ETF structures matter because they can affect the level of risk in an ETF as well as the cost of managing it. While physical ETFs are the most common, it is important to understand the structure of the ETF and pick the best one for investor’s needs.
4) Know when to trade
ETFs trade on exchange, which is why many investors use them. Like stocks, an ETF can be traded anytime during the trading hours of the exchange that the ETF is listed on. This makes ETFs more liquid than a mutual fund, which only trades once a day, at the end of the day. This liquidity and the flexibility to trade when needed is attractive to investors as it allows them to prepare for opportunities when exposure to a fund needs to be increased or decreased.
Trading tip:
Markets can be more volatile near the open and close of trading hours. Consider trading ETFs after the first and before the last 20 minutes of the trading day.*
5) Understand the costs
The two costs that occur with ETFs are transaction fees and the fund’s expense ratio. Transaction fees occur when an ETF is bought or sold, while a fund’s expense ratio is calculated annually.
HOW TO BUY AND SELL ETFs
Financial professionals can contact us directly to speak with a BlackRock specialist about the investment approach of the fund and guidance on the execution of the trade.
Individual investors can work with financial professionals to create an investment approach and discuss how to incorporate iShares ETFs into their portfolio or they can invest directly through an online brokerage account.
EXECUTING THE TRADE
When executing a trade, it is important to seek price protection, especially during times of volatility. Limit and stop-limit orders can help achieve this.
The table below explains the different types of orders that can be placed during a trade, how to determine which approach is most appropriate and the potential drawbacks of each.
| Goal | Order type | Key feature | Potential drawbacks |
| When price protection is prioritized over executing the trade | |||
| Buy / sell only at the determined price | Limit order: order executes only at the price specified, or better | Full control over worst price at which trade executes (e.g. sell as long as the price is no lower than $10 USD) | Order may not execute at all (if the ETF does not reach the specified price) or may be filled only partially |
| Help protect gains / reduce losses with price limits | Stop-limit order: wait until price breaks through a specified level, then execute as limit order | Buy or sell a security following a specified price move, with full control over worst price at which the trade can execute (e.g., sell if price dips by more than 5%, but not beyond 10%) | |
| When executing the trade is prioritized over price protection | |||
| Buy / sell immediately | Market order: order executes as soon as possible at the best price available at the time | Immediate execution of the trade in normal market conditions | In times of market stress, the realized price may be the last quoted price. Also, the execution may be delayed (e.g., if trading is halted) |
| Help protect gains / reduce losses | Stop order†: wait until price breaks through a specified level, then execute as market order | Buy or sell a security following a specified minimum price move (e.g., sell if price dips by more than 5%) | |
† May also be referred to as a stop-loss or stop-market order
THINK DIFFERENTLY
The five key considerations to investing in ETFs should be used as a guide and should not be used as an all-inclusive checklist. Additional considerations, such as the ETF’s provider, their size, scale, track record and commitment to the ETF industry should be assessed. All of these factors combined play a significant role in the decision-making process.
This concludes the third module of the ETF course. Read the next module, which dives into the differences between “physical” and “synthetic” ETF structures, to continue the course.
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