Vector Insight: Two golden rules when investing in ETFs
As the exchange traded fund industry gathers momentum in Australia and new investors consider the benefits of ETFs, it is important to understand the most effective ways to invest in ETFs and avoid some simple traps. Here are the golden rules of ETF investing.
Being quoted on ASX means ETFs give you the flexibility to invest throughout the day, just like trading shares. But there are two times of the day investors should avoid trading.
The two golden rules of investing in ETFs
- Don’t trade during the first 15 minutes after market open; and
- Don’t trade after 4:00 pm.
Rule 1 - Don’t trade for the first 15 minutes on market open
When ASX opens it does so in stages, alphabetically. Starting at 10:00am and working through the list from A to Z, it takes around 10 minutes for all companies to commence trading. For example, ANZ starts trading at 10:00am while Westpac starts trading around 10:09am.
ETFs are portfolios made up of many securities. It is difficult to determine the value of the entire portfolio until after all the securities are trading. So as a general rule don’t trade for the first 15 minutes after market open or you are likely to trade outside the value of the ETF.
Rule 2 - Don’t trade after the 4:00pm close
ETF investors should also avoid trading after 4:00pm. Many investors are not aware that after the market closes at 4:00pm orders can still be entered. Between 4:00 and 4:10pm you can amend trades and enter new ones but it is difficult to determine the value of the ETF portfolio during this time. So as a general rule don’t trade after 4:00pm.
If you apply these two golden rules of ETF investing you are well on your way to investing ETFs effectively. It is also important to understand the different ways to place an order to buy or sell an ETF.
‘Market’ versus ‘Limit’ orders
When you buy ETF shares you enter a ‘bid’ price (think about ‘bidding’ at an auction). The ‘bid’ price is the price you are prepared to pay. When you sell ETF shares you enter an ‘ask’ price (think about ‘asking’ people to pay). The ‘ask‘ price is the price at which you intend to sell.
There are two ways to input your buy or sell order:
Market Order - this means you will buy or sell at potentially any available market price. This type of order guarantees your trade, but leaves you exposed on price.
Limit Order - this allows you to set the bid or ask price. This means you will not pay (or receive) any more or less than your limit price. This type of order protects your price but does not guarantee your trade.
This is best explained by an example.
Below is a screen shot of orders investors have placed for VanEck Vectors Morningstar Wide Moat ETF (MOAT). When you invest through your online brokerage account you may see a similar screen.
Example: Trading screen for MOAT
In the above example the highest ‘bid’ price for MOAT is $48.92. This is the highest price buyers are willing to pay for MOAT shares. The lowest ‘ask’ price is $49.04. This is the lowest price sellers are willing to sell MOAT shares, but the number of shares for sale (i.e. available to buy) at $49.04 is limited to 6,500.
If you want to buy more than 6,500 shares you can do this more effectively if you use a limit order as opposed to a market order because you will potentially limit the price you pay to $49.04 for your total order.
For example, if you place a limit order to bid on 15,000 shares at $49.04, 6,500 shares would be bought immediately at that price. If the value of MOAT shares remains at $49.04, more shares will become available (from a market maker) and you will be successful in buying all the shares at that price. If, however, the value of the MOAT shares moves above $49.04, your ‘bid’ for the remaining 8,500 shares will not be successful and you will need to either wait to see if the price comes back, or increase your bid price.
If on the other hand you execute a market order to buy 15,000 shares, you would get 6,500 at the ask price of $49.04 and the remaining 8,500 at $49.06, being the next ask price on the screen. Your order would be filled but you have paid an extra two cents per share for 8,500 shares by placing a market order instead of a limit order.
Trade execution through a limit order provides you certainty and protection for your trade price however it means your trade won’t happen if the market moves above your bid price. So while a limit order limits the price, it does not guarantee the trade. Conversely, while a market order guarantees the trade, it does not limit the price.
One of the advantages of ETFs is that they are traded throughout the trading day on ASX. Effective trade execution is an important part of fully realising the benefits of ETFs for investors.
For any help trading our ETFs, or for trade sizes in excess of volume on screen, please don’t hesitate to call us on 02 8038 3300.
This article is part of a series of thought leadership articles on investing in ETFs and follows on from the last Vector Insights Going back to basics.
IMPORTANT NOTICE: Issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’). This is general information only and not financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Before making an investment decision, you should read the relevant PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. PDSs are available at www.vaneck.com.au or by calling 1300 68 38 37. No member of VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance, or any particular rate of return of any VanEck funds. Past performance is not a reliable indicator of future performance. United States domiciled ETFs: VanEck Vectors ETF Trust ARBN 604 339 808 (the ‘Trust’) is the issuer of shares in the US Funds which trade on ASX under codes CETF, GDX and MOAT. The Trust and the US Funds are regulated by US laws that differ from Australian laws. Trading in the US Funds’ shares on ASX will be settled by CHESS Depositary Interests (‘CDIs’) that are also issued by the Trust. The Trust is organised in the State of Delaware, US. Liability of investors is limited. Van Eck Associates Corporation based in New York serves as the investment advisor to the US ETFs. VanEck, on behalf of the Trust, is the authorised intermediary for the offering of CDIs over the US Funds’ shares and issuer in respect of the CDIs and corresponding US Fund shares traded on ASX.