Holy procrastination. I’m just going to put this out there: this is not a sexy topic. ETFs aren’t something you’ll be dying to discuss over drinks with your friends on a Friday night nor will they make it into your Snapchat story. I think that lack of glamour, along with the fact that I’ve never purchased an ETF and had little-to-no confidence in doing so, is the reason I waited almost a month to make the plunge and buy my first one. Oops. And even though I knew the benefits of getting this done- the Roth IRA I had just opened with TD Ameritrade was silently chastising me, and I knew the sooner I put my money to work, the better - I still had to bribe myself to get started. (Yes, I made that Oreo Blizzard my b*@$#. No shame in my game.)
Hopefully after reading my last BB Investing Project post, you’ve got your Roth IRA all set up (if not, go ahead and take the 5-10 minutes to do it now. Seriously. Do it. DO IT.). Now, I decided to invest my first bit of cash into an ETF. Why? Because a) they have extremely low fees, b) they typically have steady returns, and c) I had never done it before and wanted the lesson. However, I was running into the woods blind, so I first had to do some research to get comfortable with what ETFs are all about. Here’s what I found (you’re welcome for doing the research for you):
ETFs = Exchange Traded Fund
Don’t get your undies in a bunch because it sounds like a complicated term. Here’s the technical definition, according to Investopedia:
I know this probably sounds like French to you. I’ll break it down: Let’s say your neighbor’s kids are selling fruit salad. Those tots went to the trouble to gather different types of fruit, cut them up, mix them in a gigantic bowl, and sell scoops of it to you for a price. That scoop you’re getting is basically your ETF share, and the different fruit represents stocks of different companies – you get the benefits of having the variety without having to buy an entire watermelon, bunch of bananas, pint of blueberries, etc. In this sense, it operates much like a mutual fund.
Traded like Stocks
Where these differ from mutual funds is in how they are traded. ETFs operate like stocks – you buy the shares directly from other investors who want to sell, not from the business or mutual fund itself. Think of this like cars that are purchased from private individuals: they were originally bought from a dealer, but now they are being bought and sold by individual people without having the original dealer involved.
When investing in a mutual fund, on the other hand, you are buying straight from the fund. Using the same analogy, let’s say you purchased a Camry from a Toyota dealer. Five years later, your family expanded and you need a bigger vehicle. You trade that one back in to the dealer, they put it on their used lot, and someone else buys it from them. Two years later, that individual is ready for an upgrade, so they trade it back in to the same Toyota dealer, and a different individual buys it (and so on and so forth). See how much the dealer is involved? This leads us to the next reason why ETFs are more attractive than a shirtless Channing Tatum…
They have lower fees. And considering fees are the devil, this is a HUGE bonus. Why is this the case for ETFs? Well, for one, most of them are index-related, which means it is much easier to track. They follow the market, so whatever that does, the fund does. Actively managed funds (i.e. a majority of mutual funds), on the other hand, involve a lot more research and tracking for the poor guy in charge of the fund. This makes sense – less work means less fees.
This same concept holds true for the buying and selling process – since ETFs are traded like stocks, the fund itself isn’t ever touched. Thus, if the fund managers don’t do any work to make the trade, they won’t charge you high fees. Mutual funds, on the other hand, are more work-intensive. Since purchasing a portion of a mutual fund means getting the fund itself involved (aka our Toyota dealer in our previous example), there is a lot more paperwork and processes that must be performed in order for the fund manager to properly track who is buying and/or selling what. So the higher fees for mutual funds make sense: the more “back office” work the fund manager has to do, the higher the fees.
Alright, now that you’re no longer completely ignorant on all that is ETFs, how do you go about choosing which to invest in? Well, that’s a good question, and one that I had myself. So I did what I always do in times of need – I turned to my BFF, Google. Literally, I typed in “Best ETFs 2015” and started my research there. I found some that seemed promising and looked into those further, focusing mainly on the fees for each and the historical returns that each had earned. In the end, I settled on Vanguard’s S&P 500 ETF – it had low fees, had historically decent returns (although these are never guaranteed), and wasn’t highly risky (win, win, win!). Plus, some ETFs can be quite complex, and I wanted to stick to one that was simple in its nature. No one wants to invest in something that is more confusing than the first time you saw Inception (oh hey, Leo).
Next stop: actually making the purchase. Talk about a deer in the headlights. I had made stock trades through TD Ameritrade a few times when I was a newly-minted college graduate, but I hadn’t touched them in years. Thus, I had to put my sisterly pride to the side and ask my brother for direction. He’s the family resident expert (he got his MBA from the IU Kelly School of Business) in all things investment-related, and hey, when you have an asset available, you use it. He was in a generous mood, so he patiently walked me through the process via WAY too many text messages. But I figured out how to do it, and I’m going to be honest - it is pretty easy-peasy. Here’s what you need to do to get your first Roth IRA investment started:
1) Select Your ETF
Once you logon to your account, go to the drop down menu under “Trade” and select the “Buy/Sell” option under “Stocks & ETFs.”
Click “Buy,” put in the quantity you want to purchase, and enter your ETF symbol (Vanguard’s S&P 500 ETF symbol is VOO). Note, you have to make sure you have enough money in your account to not only cover the cost of the shares you will be buying but also the transaction fee. TD Ameritrade charges $9.99 for every trade, so if you want to keep these fees down, trade less often.
2) Set Your Price
Here’s where I really utilized my brother’s knowledge – I had no idea what a good price would be at which to buy this ETF. He said that you want to get it for under the NAV (Net Asset Value) price on the account. When he said this, I thought, “Jesus Christ, this was supposed to be simple and now you’re throwing acronyms at me.” However, it really isn’t a hard concept. Basically, the NAV represents the underlying prices of all of the stocks within that fund. Let’s look at an example:
Let’s say the ETF is made up of 3 stocks – Apple, Nike, and Kate Spade – and each trade in the regular stock market at $10 each. Thus, the NAV of this fund would be $30. Now, if the ETF was trading at $31, you would run the opposite way – why pay $1 more for something you could buy at a cheaper price elsewhere? Therefore, you always want to make sure you put in a purchase price lower than the NAV.
I know you’re next question because it was mine as well: how much lower? Well, track the ETF for a couple of days and see how much it fluctuates – if it’s relatively stable, then go in just under the NAV price since offering a lower “bid” price to buy it at probably won’t be successful. If you offer to buy at $30 but the ETF has been trading for a week or two around $33, no one is going to sell it to you. I mean, if you could sell your old jeans for $25, you wouldn’t settle for $20, right? Hells no, you wouldn’t. However, note that buying at NAV isn't the most horrible decision you'll ever make either - it's a fair price for the bundle and if you want to get those shares in your Roth quickly, feel free to go in at NAV.
Now, the nice thing with TD Ameritrade (and I’m assuming other online brokerages work the same) is that once you enter your ETF’s symbol, it will show you the “Bid” and “Ask” prices at the bottom of the page. The “Bid” is the highest price someone is willing to pay to purchase that particular ETF. The “Ask” is the lowest price someone is willing to sell it. It’s good information to have, but don’t let it completely control your purchase price.
Here are the other fields to enter in with your purchase:
Order Type: Limit (This will ensure that TD Ameritrade won’t buy the ETF shares for you until they reach the purchase price you’ve set or lower.)
Time-in Force: Day (If the ETF price never reaches your requested purchase price, then your order will cancel at the end of the trading day. I always like to choose this since there can be price fluctuations from day-to-day, and I’d rather re-enter my trade each day to account for this. You can save yourself money this way!)
Special Instructions: All or None (This is saying that you wanted to purchase all of the shares you’re requesting or none at all. Thus, if you want to buy 10 but only 7 are for sale at your requested purchase price, TD Ameritrade won’t exercise the trade. If you don’t care how many you get as long as you get some, then leave this field blank.)
Routing: Pick whatever you'd like - I went with the "SMART" option.
Here’s what your order may look like when all is said and done:
Once you’re comfortable with the information, hit the “Review Order” button. This will direct you to a summary page where you can – wait for it – REVIEW your order before finally taking that dive into buying your VERY FIRST ROTH IRA investment! Ah, so excited for you, lady (or gent)!
Your order status page will then magically appear, which shows your order summary. You can check this throughout the day to see if your order is processed. If it isn’t, make sure to go back the next day and re-enter your order so that you can try, try again ;)
And there you have it, folks. Your first foray into being a badass, independent lady boss – look at you, making investments on your own. I'm so proud!
If you have questions while going through the process, feel free to shoot me an email or tweet. I can’t really suggest specific ETFs (I'm no Warren Buffet and I know it), but I can offer guidance throughout the process. Now, off you go to do this yourself – good luck!