5 Things Every Investor Should Know About ETFs

After diving into the world of exchange traded funds (ETFs), are you now wondering what to look for?

Come and take a gander.

ETFs offer exposure to most sectors and asset classes with the added bonus of being liquid, transparent and tax efficient, writes Dan Burrows for SmartMoney.

While ETFs are indeed funds, an investor should still treat them like stocks. But unlike stocks, ETFs have a few identifiable quirks to look out for:

• Research. You need to know what you’re getting yourself into. The transparency in ETFs are because of the underlying index they track, so it is prudent to look over the components and allocations of that benchmark.
• Tracking error. ETFs try to replicate the returns of the underlying index and it sometimes does diverage from the actual value. in 2008, listed ETFs in the United States had an average tracking error of about 0.5%. Wider tracking errors tend to occur more often in global ETFs because of global time differences.
• Buy with limit. Never use market orders when buying ETFs. When specialists execute your trade, you will most likely not get the best price. Limit orders specify the price at which you may want to sell or buy.
• Volume. Liquidity and volume size help maintain the efficient and correct prices for ETFs. We try to focus on ETFs with at least $50 million in assets. A $20 million ETF made up of many well-traded stocks can also be as good.
• Taxes. An appealing attribute in an ETF is its tax efficiency, but it should be noted that a few ETFs do have capital gains distributions.

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