Okay, so you know how to open an online broker account. The next step on your road to fully-fledged investor status is to actually purchase some investments.
In this article we’ll look at how to buy an ETF (Exchange Traded Fund).
What is an ETF?
Before we get giddy with over-excitement, a quick reminder as to what an ETF is.
ETFs are funds traded on a stock exchange, as the full-fat version of their name suggests.
As investors buy and sell the ETF throughout the day, their price will vary.
Strictly speaking this means the exact price you pay for the ETF depends on supply and demand, rather than on the value of the assets held by the ETF.
In practice though, there is very little difference between the price of a typical ETF and the value of the assets it holds. Any differences are almost always quickly arbitraged away.1
To be completely accurate, we should note there are some obscure and illiquid ETFs where pricing and asset values may not always align.
There can also be a divergence for brief moments in extreme market turbulence – again usually only with smaller ETFs, or those holding more exotic stuff such as rarely-traded corporate bonds.
Neither factor should concern a passive investor. We should be choosing ETFs that track broad indices, and watching Netflix rather than our portfolios when the market throws a wobbly.
The art of the deal
Let’s get trading! To start we need to navigate to the trading screen.
First off, we need to find the ETF we want to trade. We find it by searching for its ticker symbol.
The ticker is the unique name given to each traded security on the stock exchange. You’ll find the ticker on an ETF’s factsheet, or perhaps from an article like our guide to low-cost funds for passive investors.
In the screen below we’ve typed in HMWO, which is the ticker for one of HSBC’s global equities ETFs:
(Click to enlarge)
The platform finds the ETF and gives us the option to trade (that’s the green arrow in the picture above).
Next we’re taken to the dealing screen:
Woah! Let’s run through the information we’re being bombarded with here.
Nice spread
The first thing you might notice is that there is a difference between the ‘Buy’ and ‘Sell’ prices. The sneaky broker is charging you more to buy the ETF than you’d get if you wanted to sell it.
This is common to all exchange traded securities (shares, bonds, investment trusts and so on):
- The bid/sell2 price reflects the market demand for the ETF. That is, what the market will pay for your holding.
- The ask/offer/buy price reflects the market supply for the ETF. That is, the price the market will charge you when selling you their holding.
The difference between the two is called the bid-ask spread. This spread in effect represents the cost of trading in the ETF, ignoring any additional trading fees levied by your platform.
For our example ETF, the spread is very small at around 0.05%3. The ETF we’ve chosen is a large and highly traded security.
For smaller, less frequently traded securities, the spread can be much wider. This means trading such an ETF costs more.4
Dealing options
Going back to the screen above, we next see two further options – ‘Deal now’ and ‘Stop losses and limit orders’.
- ‘Deal now’ does what it says on the tin – you’re looking to buy and sell at that moment in the market. The option to deal now is available during market trading hours. That’s 8AM to 4:30PM Monday to Friday for the London Stock Exchange.
- Stop losses and limit orders are different. You don’t immediately buy and sell with these orders. Rather, they are instructions to sell or buy a security if it reaches a particular price, which you set yourself. The idea is you don’t pay more than you want for your chosen security, nor sell a holding for less than you want to get for it. Passive investors in large liquid ETFs can ignore all this, but The Investor has written an article about these more advanced trading options if you’re curious.
We’ll proceed to deal now. We fill in the rest of the details, double check them, and then press the ‘Place a deal’ button.
The Final Countdown
We’re now taken to the following rather intimidating screen:
You’ll notice there’s a big flashing countdown warning us that we have only 15 seconds to accept the offered price. There’s also a fair bit of jargon. We’ll get to that in a moment.
Don’t panic! Remember to keep breathing, and that you are not launching nuclear warheads.
All we need to do is take a few seconds to triple check we’re happy with the details – that we’ve got the right ETF, that we are buying, not selling, and the value of our trade.
Should the countdown elapse the trade simply expires and all we have to do is click the button to refresh our quote. So we needn’t rush.
We click ‘Buy’. A moment later our broker cheerily confirms the trade has gone through. It will show the details of the trade in a screen like this (and will also email or message you this information):
Give yourself a mini fist pump. You’ve successfully bought your first ETF!
Jargon Busting
The last two screens saw a few new terms come up:
- PTM Levy – This is an extra £1 charge made when you buy or sell London Stock Exchange listed shares with a total trade of more than £10,000. It’s used to fund the Panel of Takeovers and Mergers (PTM). The PTM levy is not chargeable on ETFs.5 So we didn’t pay a charge.
- Commission – This is the fee our broker stings us with for buying or selling investments. Typically you pay a fee to deal in shares. Though some brokers don’t charge for trading ETFs. Ours does, billing us for £11.95.
- Stamp Duty – Not to be confused with stamp duty on property (technically, that’s called Stamp Duty Land Tax), this is an additional 0.5% charge levied when you buy shares. You don’t pay Stamp Duty when buying an ETF. So again, we didn’t have anything to pay here. That leaves more money for us to compound over time – result!
- Settlement Date – The date at which ownership of the security is transferred. We bought our ETF on 1/10/2018, and it won’t be settled until 3/10/2018. This delay is to reflect the process of legally transferring ownership between buyer and seller. In practice this isn’t a big deal – if you sell via your broker, the money will appear in your account and you can use it to purchase new investments. If you buy, the holding will appear in your list of holdings.6 For ETFs and shares, settlement is ‘T+2’ – that is, two days after the trading day. For Corporate Bonds settlement is T+2. For Gilts, T+1.
The Contract Note
All this information is formally set out on a record called a Contract Note. Your broker will provide this to you shortly after you complete your trade. Here’s a copy of ours:
You’ve bought your first ETF
So how was it for you? Hopefully you remembered to keep breathing when the 15-second countdown started and you’re still with us.
It’s really not that scary to buy and sell on the stock market. These days it’s no more complicated than buying novelty socks on Amazon.
Just remember to do your research in advance, and avoid getting drawn into day trading or other wealth-sapping activities. Make your well-researched investments, then go and do something fun and leave them to grow.
- Are you ready to invest? Have a look at some low-cost funds we favour.
Read all The Detail Man’s posts on Monevator, and be sure to check out his own blog at Young FI Guy where he talks about life as a financially free twenty-something.
- Arbitrage is when sophisticated investors with deep pockets buy one asset and sell another to pocket any anomalies in pricing.
- These terms are used interchangeably by brokers and investing nerds.
- Worked out as £0.01/£1.68
- The relationship between spread and ‘liquidity’ is very complex, something I spent a year of my life researching and investigating for work. I won’t get that year back.
- It is not charged on Open Ended Investment Companies, aka OEICs, either.
- Note that when it comes to dividends, you need to legally own the security on what’s called the ‘Record Date’ to be entitled to the dividend.
from Monevator http://monevator.com/how-to-buy-and-sell-etfs/
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