Key Points
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Take time to assess how global or industry trends are likely to affect a particular ETF.
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Not everyone with an opinion to share should be considered a resource.
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Determine how much faith you have in an ETF before buying and holding for the long term.
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There’s a lot to appreciate about exchange-traded funds (ETFs), including the way they allow you to create an instantly diversified portfolio, minimize your risks, pay far less in fees than other investment types, and easily buy and sell.
However, like any serious investment, it’s vital that you understand what you’re getting into and avoid mistakes that could cost you thousands of dollars over time.
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Mistake 1: Buying the hype
Imagine you’re sitting at a family barbecue, and your cousin begins to brag about the “amazing” investment he made. He tells you about his new ETF and its history of earning high returns. As he describes what he plans to do with the dividends, you wonder if it might help you diversify your portfolio. You know next to nothing about the ETF in question, but you would seriously like to get in on those past profits your cousin mentioned.
The issue with buying the hype is that past returns may not accurately reflect what you can expect in the future. Let’s say the “great investment” your cousin told you about was a healthcare ETF. Rather than jump in, you should ask yourself what potential issues that sector may face. After a little research, you realize that a healthcare ETF faces potential challenges caused by Medicaid cuts, tariffs, and pharmaceutical pricing practices — each of which can reduce the fund’s value and cost you money.
You can’t predict the future, but analyzing an ETF’s underlying holdings, evaluating its total costs, and considering the potential challenges it faces can help reduce the risk of financial loss. If there’s a bear market or recession right around the corner, you might think twice before investing in the consumer discretionary sector, even if it’s been doing well up to that point. Research reveals that consumer discretionary spending tends to drop during market downturns.
Mistake 2: Trying to time the market
Some seek to buy when prices are low and sell when they hit their peak. However, this strategy can (and probably will) backfire.
The problem is, it’s nearly impossible to time the market. Your investment might peak shortly after you buy it, only to rapidly decline as the hype cools. When you buy an ETF on its way up and sell as it declines, you’re missing out on the benefits associated with that holding. In other words, attempting to time the market can cost you big.
Like anything you invest in, the smart move is to learn everything you can about an ETF before you put money in. Only after you have faith in its long-term potential should you purchase the ETF with the intention of holding it for years. Unless you’re willing to stick with an investment long term, you miss out on potential compound growth and tax efficiency. Plus, holding means you can minimize your trading costs by avoiding frequent buying and selling.
Since the goal of investing in ETFs is to make money, it’s up to you to do everything you can to avoid losing any to simple investment mistakes.
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