How to Invest in ETFs

By eHow Personal Finance Editor

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Exchange-traded funds (ETFs) are a unique type of security that are part-stock and part-index. ETFs can represent shares in hundreds of companies, yet they can be traded at any time during market hours and can be bought in amounts as small as one share. There are a few things to keep in mind if you want to invest in ETFs.

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Instructions

Difficulty: Moderate

Things You’ll Need:

Prospectus
Stockbroker

Step1

Think about the role ETFs will play in your portfolio. If you're looking to find an ETF that mirrors an index like the Dow Jones, then you'll be looking for different ETFs than someone who wants to invest in a specific industry. Remember that there are lots of foreign ETFs to choose from as well.

Step2

Approach your broker with the exact number of ETFs you want to buy. You have to pay a broker's fee every time you buy or sell this type of security. The commission is the same no matter how many shares you're buying, though, so small trades can sometimes cost you more than you'll make.

Step3

Set, buy, sell and hold orders on your ETFs to help protect your investment. Just like with stocks, you can tell your broker to automatically sell your ETFs if they drop below a certain value. Many investors recommend automatic sale orders if your ETFs drop 10 percent in value.

Step4

Diversify your ETF investments. You want to have no more than 15 percent of your money invested in one industry and a maximum of 10 percent of your total investment income put into any single ETF. These limits are standard for managing portfolio risk, but you can exceed them if you think it will give you a quick profit.

Step5

Investigate the contents of each ETF before you invest. Some ETFs represent shares of many different companies and you'll want to know exactly what you're buying. You can usually get a detailed breakdown of the contents by visiting the issuer's website or reading the prospectus.

Tips & Warnings

Foreign ETFs provide more investment opportunities but also increase your exposure to risk. Remember that you'll be subject to the exchange rate when you convert your investment back into dollars and a bad rate can greatly reduce your earnings.
You need to pay attention to the index fund if your ETF tracks one. For example, the DIA ETF tracks the Dow Jones Industrial Average and often posts similar gains and losses.