3 Mistakes Beginner ETF Investors Make

Not paying attention to index benchmarks

On the whole, index ETFs have been great for investors looking for lower fees, transparency, and broad market exposure. But that doesn’t mean you should buy them blindly.

Let’s start with definitions. The Vanguard Information Technology ETF

sounds like it should cover all the big tech names, right? But dig into the details and you’ll find that while it holds Apple, Microsoft, and Nvidia, it doesn’t include Amazon, Tesla, Netflix, Meta, or Alphabet. Why?

Because VGT tracks the MSCI US Investable Market Information Technology 25/50 Index, which uses the GICS sector classification system. Under GICS, Amazon and Tesla fall under consumer discretionary, while Meta and Alphabet are classified under communication services. Unless you actually check the holdings or read through the index methodology, you’d never know that.

Here’s another case: the Invesco S&P 500 GARP ETF

. It tracks the S&P 500 Growth at a Reasonable Price Index and has an impressive performance chart going back years.

But what many investors miss is that before May 22, 2015, the fund tracked a completely different benchmark, the RAFI Fundamental Large Growth Index. Then from 2015 to mid-2019, it followed the Russell Top 200 Pure Growth Index.

These index changes mean historical performance isn’t a fair apples-to-apples comparison. You might think you’re buying into a winning formula when in reality, much of that outperformance came under different strategies entirely.

Always read the fine print. Understand what index the fund tracks, how that index defines sectors, and whether it’s changed over time.

Trading at market open and close

ETF liquidity is made possible by a mechanism called in-kind creation and redemption. This process allows large institutional players known as authorized participants (APs) to swap baskets of the ETF’s underlying securities for ETF shares, or vice versa. It keeps supply and demand in balance and helps ETFs trade close to their net asset value (NAV).

But like any complex operation, this system has friction, especially during times of heightened activity, like right at the market open and close. In the first and last 15 minutes of the trading day, it’s common for ETFs to show wider bid-ask spreads than usual.

That means the price you can buy at and the price you can sell at may be further apart, costing you more to trade. You may also notice that the ETF’s market price doesn’t quite match its indicative NAV, a signal that pricing efficiency is temporarily out of sync.

These discrepancies happen because the underlying securities may still be adjusting to overnight news at the open or seeing a flurry of end-of-day trades at the close. That uncertainty makes it harder for market makers and APs to price things accurately in real time.

If you’re placing trades during extended or overnight hours, the problem can be even worse. Underlying markets might be closed entirely, which means ETF prices are moving without any tether to the real-time value of their holdings. Unless you really know what you're doing, it’s smarter to trade ETFs during normal market hours and avoid the open and close.

Ignoring tax treatment

ETFs are often praised for being more tax efficient than mutual funds. Thanks to the in-kind creation and redemption process, ETFs can avoid triggering capital gains when investors enter or exit the fund.

Authorized participants handle redemptions by delivering shares of the underlying holdings rather than selling them for cash, which means the fund doesn’t need to realize capital gains and pass them on to shareholders.

But that’s just one part of the tax equation. Some ETFs generate income that’s taxed much less favorably than others, depending on how they’re structured.

 A good example is the JPMorgan Equity Premium Income ETF

. It boasts an impressive 30-day SEC yield of around 11%, but there’s a catch: much of that income is derived from equity-linked notes (ELNs) used in its covered call strategy.

These are considered derivatives, so the resulting distributions are usually taxed as ordinary income, not as qualified dividends. That means a much higher tax bill if you hold it in a taxable account.

Another headache to be aware of is the dreaded Schedule K-1 tax form. This form is typically issued by ETFs that hold commodities or volatility-linked futures. These funds are often structured as limited partnerships, and owning them means you become a “partner” for tax purposes.

The K-1 is notorious for being confusing, late to arrive, and burdensome to file, even if your position was small or short-term. The wrong fund can leave you with an unpleasant surprise come tax season.

Please note that this article reflects the author’s personal views and does not represent the opinions of the publication or its affiliates. It is for informational purposes only and does not constitute investment advice. It is essential to seek guidance from a registered financial professional before making any investment decisions.