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. We’re using Hargreaves Lansdown in our example, but the process is similar for other platforms.

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:

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.

1. Arbitrage is when sophisticated investors with deep pockets buy one asset and sell another to pocket any anomalies in pricing. [↩]
2. These terms are used interchangeably by brokers and investing nerds. [↩]
3. Worked out as £0.01/£1.68 [↩]
4. 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. [↩]
5. It is not charged on Open Ended Investment Companies, aka OEICs, either. [↩]
6. 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. [↩]

What caught my eye this week.

A short while ago the UK blogger DIY Investor wrote passionately about the threat of climate change. He’s now put money into the Impax Environmental Investment trust in part to do something about it:

As I was writing my article on climate change recently, I must admit to a feeling of guilt that I did not hold a ‘green’ fund in my portfolio.

I have some reservations regarding this sector and suspect many funds are not really as green as they make out.

However some are clearly better than others [and] I think that being aware of a potential problem brings with it a responsibility to do something positive.

So, time to make amends.

We get a fair few queries about ethical / SRI1 investing. In response, The Accumulator wrote a big article about it last year, with a tilt towards passive options.

What jumped out at me from DIY Investor’s write-up though was this section from Impax on the happy consequences of buying a big wodge of its shares:

Environmental impact of £10m investment in IEM plc

• Net CO2 emissions avoided 7,940tco2
  Equivalent to taking 3,940 cars off the road for a year

• Total renewable electricity generated 2,150 MWh
  Equivalent to 520 households’ electricity

• Total water treated, saved, or provided 2,340 megalitres
  Equivalent to 18,500 households’ water consumption

• Total materials recovered/waste treated 1,340 tonnes
  Equivalent to 1,340 households’ waste arising

I am as concerned about the environment as anyone I know. I applaud the aims of both the trust and my fellow blogger.

However I can’t decide whether buying into a trust like this really equates to anything like the impact quoted above.

I’m not doubting the underlying green businesses which it invests in. I haven’t researched them.

Rather, if you buy shares of an investment trust in the open market, you’re simply swapping your money for the shares of someone else. You now own a bunch of companies achieving those lofty targets – but now somebody else does not. Surely it’s a zero sum trade?

It’s only when the fund raises money that new funds will go into the sector.

That’s on the one hand.

On the other hand, the greater the demand for assets like this, the stronger the secondary market and the easier such companies – and funds – will find it to raise money in the future.

So on balance I think owning the fund does no harm and probably a little good – but it would be best to buy into such trusts when they first raise money if you want to make the most impact.

Of course, I own Tesla shares and console myself for putting up with their volatility with the importance I see in its mission.

But then again that electric car / battery / controversy maker will certainly need to raise money again in the future if it’s to achieve its ambitions. Hence its shares really do need all the support they can get.

Do you consider ethical factors when making an investment – and would you feel easier flying to Spain on the back of it?

Let us know in the comments below.

[continue reading…]

1. Sustainable, Responsible, Impact Investing. [↩]

Whether you’re only now peaking out from behind the sofa or you’ve been investing passively like a trooper and refusing to look at your portfolio until Boxing Day, if you’re reading this site you’ve probably seen headlines implicating US bond yields in the recent assault and battery on the stock market.

For example:

• Surging yields raise threat of tipping point for stocks – Wall Street Journal

• Here’s why stock-market investors suddenly freaked out over rising bond yields – MarketWatch

• Treasury yields are increasing again, reigniting concerns about higher rates in financial markets – CNBC

Are pundits in this game of financial Cluedo right to finger Mr Treasury Bond in the trading den with a cudgel as the villain?

As always – who knows. There are plenty of dodgy-looking drifters riding around stock market town at the moment and occasionally firing their guns into the air, from geopolitical tensions and rising oil prices to high valuations in the US and its trade spat with China.

Any of those other factors – and more, or perhaps nothing specific at all – could have been the trigger for what wasn’t a particularly large correction anyway, especially in America.

Investing nerds like me still debate what caused the huge 1987 crash. We can’t expect a definitive answer to what’s so far been a run of the mill wobble.

Higher rate hate

All that said, I suspect sharply rising Treasury yields are probably having an impact in various ways on the market.

In particular, the commentary from US central bankers that there may be several more rises to come seems to be vexing in some quarters.

Many of the same commentators and traders who chastised the US Federal Reserve for a decade for suppressing rates to record lows now seem happy to put the boot in again when rates are rising.

Given markets move on sentiment in the short-term, this sound and fury can make a difference.

The obvious question is why do rate rises matter, anyway?

After all, a US 10-year government bond is still only yielding a little over 3%. For almost all the post-World War 2 period, that would have been considered bargain basement.

Also, why should UK investors care? We’ve seen a couple of rate rises here, but our yields are still much lower than in the US.

Isn’t everything bigger in America? Why not the yield on the 10-year Treasury bond?

Alas, contrary to some wishful thinking in recent years, we do not live on a financial island in splendid isolation. Warren Buffett calls US government bond yields the gravity of financial markets, and we almost invariably feel the impact here of major developments there.

For example, the relative attractiveness of putting money in a US bank instead of a UK or European bank can move both our bond markets and our currency, by influencing the behaviour of massive and rootless capital flows. Money tends to go to where it’s treated best.

As for rising yields themselves, I’ve had a few queries about this both here and in the archetypal pub.

I’m certainly not a bond expert or a stock market historian – some of our readers are far more knowledgeable about the mechanics of the yield curve than me!

Nevertheless I did make a fair fist of explaining the potential issues arising from the prolonged low interest rate era back in late 2016.

It seemed to me then that Central Banks were ready to start closing the spigots on super-easy money. Politicians, too. I mused that they feared that the core business model of banking risked becoming unprofitable, with unpredictable knock-on affects.

I’m not sure that’s proven out, but the rate rises have certainly started, at least in the US and UK.1

On the down low

Bond yields rising off the floor may matter to traders and analysts long before they are seen in costlier mortgages or over-indebted ‘zombie’ companies going bust.

As I wrote in my long piece:

A discounted cash flow model puts a discount on the future cash due. This reflects the uncertainty about future profits, as well as inflation and interest rates.

Normally, distant payouts are deeply discounted. But with the risk-free rate so low that doesn’t happen so much.

Why does this matter?

Because uncertain future forecasts have grown in importance compared to near-term cash flows. A discount rate of 2% doesn’t have much impact until you get far out.

This makes the present value of an asset even harder than usual to determine with confidence. Because future cash flows assume greater importance, the valuation is based on more finger-in-the-air guesswork.

It’s a nerdy-sounding but important point that may mean market valuations are wildly off. Even a modest rise in rates could cause a crash in all sorts of assets beyond what we’d expect.

I’ve heard a couple of people ask why technology shares that pay no dividend fell the most in last week’s kerfuffle.

Nobody owns those for income. Surely it should be utilities or ‘dividend stalwarts’ like Unilever and Johnson and Johnson that should be most marked down, if nervous investors believe they can now get the regular cashflows they require from bonds again?

That makes sense, and I do think the relative attractiveness of dividend-paying companies compared to government bonds will shift over time if rates keep rising.

But it’s the change in the discount rate that explains the theoretical shift in the valuation you’d put on say an ASOS or an Amazon, or even a Fevertree. The companies may rapidly start looking more expensive in an analyst’s model, even if nothing has changed in the business itself.2

Anyway, rather than rehash that article again here I’d suggest rereading those two previous pieces for more on how low yields may have distorted things in the past decade. Unwinding such distortions, where they exist, seems bound to have some impact.

Here are the links:

• Understanding the low interest rate era

• The problem with low interest rates

Also, if you tend to read Monevator via email or you don’t check back on the comments much, you will have missed the long thread that followed the latest Weekend Reading.

If you are feeling blue after a kicking that – incredibly enough – at one point had the FTSE 100 back at 1999 levels, you might at least find some comradeship in the thoughts of fellow readers.

(Thanks again for sharing all!)

1. The Federal Reserve further announced in late 2017 that it was beginning to reverse QE – what it calls ‘Policy Normalization’. [↩]
2. The more prosaic reason they fell farthest is that people dump pricey growth shares in times of panic! [↩]