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Seeing the pros and cons of trading ETFs

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One supposed advantage of trading ETFs is that, unlike the regular index mutual funds I recommend in this book, you can trade (buy or sell) ETFs throughout the weekdays when the stock market is open. When you buy or sell an index mutual fund, your transaction occurs at the closing price on the day that you place the trade (if the trade is placed before the market closes).

Sure, the flexibility of ETFs sounds alluring, but consider a few drawbacks:

 Timing your moves in and out of the stocks: Being able to trade in and out of an ETF during the trading day isn’t a necessity, nor is it even a good practice. In my experience of working with individual investors, most people find it both nerve-racking and futile to try to time their moves in and out of stocks with the inevitable fluctuations that take place during the trading day. In theory, traders want to believe that they can buy at relatively low prices and sell at relatively high prices, but that’s far easier said than done.

 Paying a brokerage commission every time you buy or sell shares: With no-load index funds, you generally don’t pay fees to buy and sell. But with ETFs, because you’re actually placing a trade on a stock exchange, you pay a brokerage commission every time you trade through some brokers. For example, if you buy an ETF with a seemingly low expense ratio of 0.1 percent and you pay $10 to trade the ETF through an online broker, that’s equal to paying two years’ worth of management fees if you invest $5,000 in the ETF!

 Figuring out whether the current price on an ETF is above or below the actual value of the securities it holds: Because ETFs fluctuate in price based on supply and demand, when placing a trade during the trading day, you may face the uncertainty and complication of trying to determine (if you care) whether the current price on an ETF is above or below the actual value of the securities it holds. With an index fund, you know that the price at which your trade was executed equals the exact market value of the securities it holds.

Because ETFs trade like stocks, you can use limit orders and stop loss orders as well as sell them short or trade them on margin. I generally don’t recommend these strategies for nonprofessional investors.

Mutual Funds For Dummies

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