3 ETF Investing Strategies to Avoid

There are at a few investment strategies that you should avoid with ETFs. An exchange traded fund (ETF) is designed to give an investor with a way to mimic or match the returns of the fund’ underlying index without having to by the individual shares in the index. An ETF can be based on the index that tracks 30-year U.S. Treasury Bonds, Municipal Bonds, currency funds, and stocks such as the Dow Jones Industrial Average or the S&P 500. The ETF seeks to be of the market and not away from it. What this means is that an ETF is a passively managed fund whose performance should almost exactly match that of its index. This differs from actively managed mutual funds, which have higher commissions and fees than ETFs. There are a few common errors that people make when they use ETFs:

Investing in ETFs Based on Returns

Many times an investor will purchase an investment based on the advice of a friend who did well in a particular security. The problem with this approach is that often times the performance that your friend achieved is not the performance that you should expect to receive for the same security. This principle holds just as well for ETFs as it does for stocks and other security investments.

An ETF should be based on your personal investment objectives, goals and risk tolerance and not based on its past performance. All this is easier said than to follow, track the historical performance of 3 or 4 ETFs with the highest returns currently and see how many years they have achieved those returns. What you will find is the variable nature of investment returns and what is up today most likely was way down yesterday and may be down again tomorrow.

Trading Exchange Traded Funds like Stocks

ETFs, like other types of investment company shares, are meant to provide stability of returns in a portfolio by reducing some of the risk of volatility through diversification. Treating an ETF like a stock to be bought and sold will result in high transaction costs and tax issues with respect to the treatment of short term capital gains that are higher than the taxes payable on long term capital gains.

Staying in a Bad Asset Class

Finally, an ETF investor should know when to be in a sector or segment of the market, referred to as an asset class (i.e. stocks, bonds, commodities and futures, etc.) and when to shift or diversify holdings. Placing all of your “eggs in one basket” based on the performance of the sector and not reacting fast enough to changes in the market will result in losses that may have been avoidable.

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