Sector bets, shorting, and parking cash
It’s time to get your exchange traded game on.
Once you’ve got your head around the concept of ETFs and how to get into the market with them — the basic idea being to use them, in a relatively inexpensive way, to cover the kinds of shares that you might not have already acquired — what’s next?
The answer: it’s time to strategize.
In this, the third posting of a Wall Street Survivor series about exchange-traded funds, we’ll look at how exchange-traded fund investors work with ETFs to make money in more complex ways.
Some of the strategies below will benefit from understanding other market terms and concepts. We’ve included some quick definitions to keep you moving.
Stock v. Sector
A lot of writing about exchange-traded funds presupposes that the investor isn’t actually an expert on the stocks that the fund contains. But what if you know a lot about one or more of what’s in the ETF? If you think a particular company is going to do better or worse than its sector, you can play the two off each other, going long on the stock or fund that you think is going to increase in value and shorting the other.
Quick Def: Short Selling: Shorting a stock is when you borrow some shares from a broker, sell them high and then replace the shares you borrowed by buying them back at a lower price and keeping the difference.
Unlike regular stocks, you can short-sell an ETF the minute you see its last price dip below the number before that. Say, for example, you bought into FIXANTs, a fictitious ETF that represents stocks in various companies in the industrial adhesives sector. Say you go to your broker and “borrow” your way into the ETF when they cost $25. You sell and take in your cash, and then FIXANTs dips to $24.70 and then to $22. At that point you buy up the same amount you sold and you keep the $3 difference when you “return” what you borrowed to your broker.
Expanding into Bond ETFs
Exchange-traded funds; they’re not just for company shares. You can put your money down on ETFs that track bond indexes, too. The advantage to getting into bonds is that, as with other kinds of exchange-traded funds, you can quickly incorporate numerous kinds of them into your portfolio — short- to long-term all at once.
Examples: Buy 10 shares of BND, an ETF that covers the entire bond market
Cash Growth and Bond ETFs
Another bond-related trick is to “park” cash in short-duration bond ETFs, waiting for your investment to build up to a yield that can be double or triple what a comparable money market fund.
Quick Def: Yield: The amount that a bond pays out when it reaches its set point of maturity.
Quick Def: Money Market: A type of mutual fund comprised of short-term securities (think U.S. Treasury bills, for example). They are considered low-risk, and tend to bring in comparably modest returns.
With these strategies in mind, you can start learning your way into the more advanced realm of ETF management. Be careful, however, there are many opportunities in these methods to rack up fees and trade yourself into a low-profit scenario. There’s also plenty of room for things to simply go a different way than you had planned (when your stock v. sector prediction doesn’t pan out, for example).
In the next installment of this series, we’ll turn to the sometimes confusing similarities and differences between exchange-traded funds and their cousin the mutual fund. And then we’ll turn to ways to handle the tax implications that come with getting out of ETFs. Keep reading. And good luck, investors!