What to Know Before You Buy ETFs

Why are you buying an ETF? Are you looking for some broad market exposure? Do you want to invest in a certain industry? Are you looking to hedge a segment of your portfolio? Determining the correct investment strategy will set you on the correct path of picking the most effective ETF.

From general market and index funds to specific sector or region funds or even commodity funds, there is most likely an ETF or ETN to fit your strategy.

How long do you plan to hold this ETF? Are you in for the long haul or is this a short-term investment? There are different advantages and disadvantages of ETFs depending on your investment horizon.

Research your chosen ETF and all of its holdings. Even though you are looking for overall country, market, or sector exposure, that doesn’t mean you shouldn’t examine the equities in an ETF. Just as you would scrutinize any stock before you invest, you should research all the assets in the ETF. If there is any equity that could hinder performance (in your opinion), it may not be the ideal investment for your portfolio.

ETFs can be a cost-effective investment in most cases, but you still have to weigh the related costs of an ETF against similar investments like indexes and mutual funds.

Some ETFs are close-ended and therefore carry extra management fees. Also, if you are actively trading ETFs make sure to include commissions in your cost calculations. Be aware of all related costs before purchasing an ETF.

And when it comes to trading fees, ETFs are cost-efficient. When you buy or sell an index basket, you pay commissions on each trade within the basket.

Same with mutual funds. When you buy or sell an ETF, it’s one trade, one transaction, one commission. And while some ETFs have management fees, they generally tend to be lower than mutual funds, so more savings there as well.

How is the purchase or sale of an ETF going to affect your tax return? While U.S. based ETFs have many tax advantages, a foreign ETF may not be so tax-friendly and therefore not cost-effective. Tax implications vary from region to region.

The beauty of ETFs is that they are easy to buy and easy to trade. To buy an ETF all you need is a discount brokerage account. And ETFs, for the most part, are liquid and trade openly during market hours.

However, that doesn’t mean you should just jump in the ETF waters without considering the factors that may or may not make these investments the right choice for your portfolio.

Yes, you read that right. You can buy an ETF and actually put on a short position. They are called inverse ETFs, and they allow you to inversely track an index or underlying asset without having to worry about margin restrictions or short selling. Get short by getting long an inverse ETF.

We’ve outlined many reasons to buy ETFs (and ETNs) already, but there are many more as well. ETFs are great plays for earnings season. There are leveraged ETFs for investors who have higher risk tolerance, and traders can play volatility with ETF option straddles. The strategies are limitless.