Exchange Traded Funds (ETFs) are growing in popularity by the day, with Australians now entrusting nearly $40 billion of their savings in these products.
Self-managed super investors are increasingly embracing ETFs as a low cost and flexible means to diversify their portfolios, and the latest figures from Investment Trends show an additional 36,000 SMSFs intend to invest in ETFs in the next 12 months.
ETFs are listed managed funds that trade on the stock exchange in a very similar way to individual shares. However there are a number of nuances specific to ETFs (versus individual shares) that investors should be aware of when they trading these funds on the stock exchange.
First things first
To purchase shares in an ETF, investors select the ETF they would like to invest in noting the three or four letter ‘ticker’ applicable to that ETF, they place an order to buy (or sell) the ETF on the exchange through a full service or online broker.
Limit versus market orders
There are two ways you can structure your order (or purchase) shares in an ETF – you can make a limit order or a market order.
Limit orders let you determine the maximum or minimum price at which you’ll purchase ETF shares. So you can specify that you won’t follow through with the purchase either over or under a certain dollar amount.
In this way limit orders offer you control over the price. However you do risk that your order won’t be completed if your criteria are not met within a certain timeframe.
It can be a good idea to use a limit price for your ETF orders as opposed to using market orders to ensure your order is executed at a price you are comfortable with.
Market orders mean you request your purchase of units in the ETF at the best available price, and there will be no doubt on the purchase being completed. However it is possible you will receive an undesirable price for your trade using a market order.
Consider market volatility and news
Be wary of trading ETF shares during volatile periods or when there are major events that are affecting markets.
Market volatility can cause the prices of an ETF’s underlying securities to move sharply, which can in turn cause the ETF’s shares to have wider bid-ask spreads or larger premiums or discounts.
Investors should also pay attention to market news as ETF prices may swing in response to the release of economic indicators or announcements from the likes of the Reserve Bank of Australia, as well as earnings and other news from companies that are large constituents of an ETF.
Limit orders may be beneficial in such situations because of the price protection they provide.
Best time to trade
Whenever possible it is best to avoid trading in the first 20 minutes of the trading day – the Australian market opens at 10am – to allow markets to fully open and market participant’s time to appropriately price the ETFs.
At the market’s close at 4pm, fewer firms may make markets in an ETF as market participants try to limit their risk, so fewer shares may be listed for purchase and sale than at other times of the day.
Benefits of ETFs
If you are one of the thousands of SMSF trustees planning to begin investing in ETFs, these funds can provide your portfolio with a broad exposure to thousands of shares in one trade, many are low cost and can provide access to markets previously difficult and expensive for individual investors.
In this way they can serve to provide instant diversification to your retirement savings.