A Beginner's Guide To Investing In Etfs With Fidelity

Exchange-Traded Funds (ETFs) are a popular investment vehicle, providing investors with access to a basket of securities that can be traded through a brokerage firm on a stock exchange. Fidelity offers a wide range of ETFs, including active, thematic, sustainable, stock, sector, factor, and bond ETFs, all of which can be purchased online without commission fees. When investing in ETFs through Fidelity, it's important to consider costs, dividends, and taxes, as these are key aspects of ETFs. Additionally, Fidelity provides resources such as screeners and research tools to help investors make informed decisions about which ETFs align with their investment goals and risk tolerance.

Understanding the basics of ETFs

An exchange-traded fund (ETF) is a basket of securities that you can trade through a brokerage firm on a stock exchange. ETFs are bringing tremendous innovation to investment management, but as with any investment vehicle, they come with risks. ETFs are subject to market fluctuation and the risks of their underlying investments. They are also subject to management fees and other expenses.

ETFs are highly transparent investment vehicles. They can be more tax-efficient compared to some traditional mutual funds. Generally, holding an ETF in a taxable account will generate fewer tax liabilities than if you held a similarly structured mutual fund in the same account.

There are different types of ETFs, including active equity, fixed income, thematic, sustainable, and more. Some ETFs attempt to track the performance of an index. Knowing how those indexes are constructed and maintained is an important part of choosing an ETF. Sector and industry ETFs are a dynamic and growing market, with multiple indices tracking industry performance.

Bond ETFs offer the benefits of bonds and may be worth considering if you're looking for fixed income. International ETFs can be an effective way to diversify your equity holdings by providing exposure to faster-growing economies around the world.

How to choose an ETF

When choosing an ETF, it's important to know what to look for. Here are some key considerations:

Costs, Dividends, and Taxes

Understanding the costs, dividends, and tax implications of an ETF is crucial. ETFs are known for their low costs, but it's important to be aware of any management fees, transaction fees, or other expenses associated with the fund. Additionally, knowing how dividends are distributed and their potential impact on your tax liabilities is essential.

Liquidity

ETFs generally trade close to their fair value, and premiums or discounts tend to be short-lived. However, it's important to understand the difference between primary and secondary liquidity in an ETF. This can impact your ability to buy or sell the ETF at a desired price.

Tracking Error and Tracking Difference

Tracking difference is a crucial metric to assess ETF performance. It measures how well the ETF is replicating the performance of the index or benchmark it is tracking. Tracking error, on the other hand, refers to the deviation between the ETF's returns and those of its underlying index.

Expense Ratio, Tracking Results, and Capital Gains History

When evaluating an ETF, it's important to consider its efficiency by examining its expense ratio, tracking results, and capital gains history. A high expense ratio can eat into your investment returns, so look for ETFs with competitive fees.

Transparency

One of the appeals of ETFs is their transparency. You can easily find information about the fund's holdings, investment strategy, and performance. This transparency allows you to make more informed investment decisions.

Investment Objectives and Risk Tolerance

Different ETFs have different investment objectives and levels of risk. Some ETFs may focus on capital appreciation, income generation, or a combination of both. It's important to choose an ETF that aligns with your investment goals and risk tolerance.

Diversification

ETFs offer built-in diversification by holding a basket of securities. However, it's important to consider the underlying assets and their correlation to each other. Diversification can help reduce risk and improve long-term performance.

Sector and Industry Focus

Consider the sector and industry exposure of the ETF. Some ETFs focus on specific sectors or industries, such as technology, healthcare, or renewable energy. Choosing an ETF that aligns with your interests and areas of expertise can be advantageous.

Active vs. Passive Management

ETFs can be actively or passively managed. Actively managed ETFs seek to outperform an index and offer more trading flexibility, while passively managed ETFs aim to replicate the performance of an index. Each has its own advantages and considerations.

Fund Size and Trading Volume

Larger ETFs tend to have higher trading volumes, which can impact liquidity and the ease of buying or selling the ETF. Additionally, larger funds may have more established track records, making it easier to evaluate their performance.

Research and Due Diligence

Before choosing an ETF, be sure to do your research. Look at the fund's prospectus, performance history, and the reputation of the fund provider. Consider seeking insights and data from Fidelity's professionals and ETF research tools to make more informed decisions.

ETF trading tips

Costs, Dividends, and Taxes

Understanding the costs, dividends, and tax implications of ETFs is essential for making informed investment decisions. Costs can impact your returns, while dividends can provide income, and taxes can affect your overall profits.

Liquidity

ETFs generally trade close to their fair value, and premiums or discounts tend to be short-lived. Understanding the primary and secondary liquidity of an ETF can help you make better trading decisions.

Tracking Error and Efficiency

Evaluating a fund's tracking difference, expense ratio, tracking results, and capital gains history is crucial for assessing ETF performance and choosing the most efficient investment options.

Spreads and Volumes

Bid/ask spreads, trading volumes, and market impact are critical factors in ETF trading. Understanding these elements can help you make more strategic trading choices.

Trading Strategy

Fidelity offers a range of active and passive exchange-traded funds. Active ETFs offer the potential to outperform an index but may also trail it more significantly compared to passive ETFs. Consider your investment goals and risk tolerance when choosing between these options.

Diversification

Mixing styles in your portfolio, such as combining different sectors or industries, can help achieve diversity and potentially improve performance. Fidelity's ETF screener can help you identify ETFs and ETPs that match your investment goals.

Risk Management

While ETFs offer benefits, they also carry risks. Understanding the risks associated with the underlying investments of an ETF is crucial. These risks may include market volatility, interest rate risk, credit risk, and more.

Costs, dividends, and taxes

When investing in ETFs, it is important to understand the costs, dividends, and taxes associated with them. Here is a breakdown of each:

Costs

Fidelity offers a range of ETFs with competitive pricing and trading flexibility. When checking out ETFs, it is important to consider certain costs, such as management fees, activity assessment fees, and transaction-based service fees. For example, the sale of ETFs is typically subject to an activity assessment fee, historically ranging from $0.01 to $0.03 per $1,000 of principal. Additionally, a limited number of ETFs charge a transaction-based service fee of $100. It is important to review the prospectus and related documents to understand all applicable costs.

Dividends

If you own shares in an ETF, you may receive distributions in the form of dividends. Fidelity offers various dividend-focused ETFs, such as the Fidelity® Dividend ETF for Rising Rates (FDRR), which targets higher-yielding companies with a positive correlation to rising Treasury yields. Dividends can provide a source of income and are an important aspect to consider when evaluating potential ETF investments.

Taxes

From a tax perspective, ETFs generally offer more tax efficiency compared to traditional mutual funds. Holding an ETF in a taxable account typically generates fewer tax liabilities than holding a similar mutual fund in the same account. However, it is important to understand the basic tax rules for gains and losses on ETFs. Usually, there is no gain or loss until you sell your ETF shares, but there are exceptions. To determine your gain or loss when selling, you need to know your basis, which is a tax term with a specific meaning. Additionally, special tax rules apply to commodity ETFs, as the legal structure and type of ETF affect the tax results for investors. It is always recommended to consult with a tax professional for specific guidance regarding your tax situation.

ETFs vs. mutual funds

Exchange-Traded Funds (ETFs) and mutual funds are similar in that they are both professionally managed collections or "baskets" of individual stocks or bonds. They are both less risky than investing in individual stocks and bonds and offer a wide variety of investment options. They are also overseen by professional portfolio managers.

However, there are some key differences between the two. ETFs trade like stocks and are bought and sold on a stock exchange, whereas mutual funds can only be purchased at the end of each trading day based on a calculated price known as the net asset value. ETFs do not require a minimum initial investment and are purchased as whole shares, whereas mutual funds have minimum initial investments that are normally a flat dollar amount. ETFs are usually passively managed and track a market index or sector sub-index, while mutual funds are usually actively managed. ETFs can be more tax-efficient than mutual funds because they may have lower turnover and can use the in-kind creation/redemption process to manage the cost basis of their holdings.

When choosing between ETFs and mutual funds, it's important to consider your investment goals and your risk tolerance. ETFs are generally more suitable for those who want lower investment minimums, more hands-on control over the price of their trade, and the ability to trade throughout the day. Mutual funds may be more suitable for those who want to keep things simple, make automatic investments or withdrawals, or have more active management.

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