How to Get Started in ETF Investing for Beginners (an easy how-to guide)
If you’re ready to make money in the stock market, but don’t know the first thing about how to get into stocks, this is your opportunity to learn the basics of ETF (Exchange Traded Fund) investing.
Whether you’ve bought and sold the occasional stock in the past, are an old hand at mutual fund investing, or are looking at stocks for the very first time, you can learn everything you need to know about how to invest in ETFs, regardless of your current knowledge or previous experience.
Everyone is a beginner when they start their investment education, but with a little focus and determination, you’ll soon become a confident investor, ready to reap all the financial benefits that ETF investing has to offer.
What is an ETF?
An Exchange Traded Fund (ETF) is simply a collection, or portfolio, of various assets, such as stocks or bonds, that is traded as a single unit on the stock market.
When you participate in ETF investing, you buy shares in a broad range, or index, of companies or financial securities. This gives you the advantage and convenience of owning small pieces of a wide variety of businesses, instead of having to research, buy and manage shares in a large number of individual stocks or bonds.
Unlike mutual funds, ETFs don’t require the active management of a financial advisor to help them offer higher returns than the average commodity traded on the stock market, because they aren’t designed to beat the market.
Instead, ETFs are specifically created to track, follow and provide returns based on the overall performance of a particular sector of stocks or bonds, or of an entire market such as the S&P 500.
An ETF’s holdings, for example, may range from a group of stocks related to and representing the healthcare sector, to a bundle that includes all the major representatives of the Dow Jones market. But regardless of an ETF’s specific holdings, its goal remains the same: to provide investors with a diversified portfolio that trades as a single stock, and that replicates and yields the returns of the market it represents.
Exchange Traded Funds are one of the best investments for helping you to build long-term wealth.
ETF prices rise and fall throughout the trading day just like the price of any single stock on the market does, but they tend to trade at higher volumes because they represent a broad group of stocks. This offers the advantage that your ETF investment will remain more liquid, or easily sold, than the shares of any single stock may on its own.
But although you can quickly and conveniently buy and sell ETFs on the stock market, you don’t have to. ETFs are a great investment vehicle for buying and holding for the long-term because of their minimal management requirements, and they should ideally make up a significant portion of your investment portfolio.[alert-note]⇒ Investing Tip: ETF is the best investment vehicle for building your long-term wealth![/alert-note]
ETFs are Much Better than Mutual Funds
Exchange Traded Funds are essentially the same as mutual funds in that they both hold diverse portfolios of financial securities, designed to track the performance of specific indexes. But as we will see, there are three major advantages to investing in ETFs instead of in mutual funds:
- Less risky fund management
- Lower trading and holding costs
- Higher trading convenience
Mutual funds are actively overseen by portfolio managers who are constantly buying and selling fund-owned stocks in an ongoing attempt to hold the best possible collection of financial securities. The goal of these managers is to beat the market average in terms of investment returns and as a result, they are always on the look-out for stocks that they think will outperform the market. But while market knowledge and trading expertise can go a long way toward knowing what to look for in terms of a stock’s potential, the bottom line is that there is no guaranteed method for choosing high performance stocks with consistently high profit yields.
Those who value the supposed advantages of an actively managed fund are willing to pay the high fees demanded by mutual fund investing, but ETF investors benefit from a far more passive management style.
These funds require that a manager make only minimal and occasional asset adjustments in order to keep a portfolio in line with its given index.
So, instead of investing in a fund manager, who will always put you at risk in terms of their investment decisions, when you buy shares in an ETF, you will be investing in the power of the stock market itself.
One of the biggest advantages of ETF investing is that its passive management approach means you will pay very low fund management fees.
While traditional, actively-managed mutual funds generally demand fees of anywhere from 1-2% or higher, ETF fees by comparison usually fall in the range of 0.1 to 1%.
While that may not sound like a very big difference at the outset, over the long-term it can add up to an enormous amount of cash that is far better off in your pocket, than in that of a mutual fund manager who gets paid regardless of how well their stock choices perform.
In addition to their higher management fees, mutual funds can also be difficult to trade. Most investors have to rely on their financial advisors for assistance with this, making mutual funds more costly in an entirely different way, since many ETFs can be traded easily and commission-free through online stock brokers.[alert-note]⇒ Investing Tip: Don’t invest in mutual funds – Choose ETFs instead![/alert-note]
Where to Buy ETFs
1. SPDR ETFs
SPDRs (Standard & Poor’s Depository Receipts), commonly called “spiders”, are Exchange Traded Funds that specifically track the S&P 500 stock market.
SPDRs are managed by a company called State Street Global Advisors (SSGA), and are available in various bundles of stocks.
You can learn more about everything SPDRs have to offer at the SSGA website: https://www.spdrs.com/.
2. iShares ETFs
iShares are a large group of ETFs, managed by a company called BlackRock.
These funds track a variety of stock and bond market indexes, and like most ETFs, they can be purchased directly through an online brokerage account.
In comparison with more costly mutual funds, iShares claims to have outperformed as many as 90% of actively managed funds in the S&P category over the past five years.
For details on this and many other ETF strategies and advantages, you can visit the iShares website at: https://www.ishares.com/us/.
3. Vanguard ETFs
Vanguard operates as both a brokerage firm and a fund management company for their ETFs.
They launched the very first index fund for individual investors, and they continue to offer a variety of stock, bond, sector, and even international funds.
You can learn more about Vanguard ETFs, and trade them commission-free, at the company website: https://investor.vanguard.com/etf/.
How and Where to Research ETFs
All of the ETF provider websites mentioned here are great resources for learning more about how to invest in ETFs, and for researching specific funds you can invest in today.
Many ETF providers offer investors a wide range of fund options that allow you to choose from those designed to track a particular stock market, a specific stock market sector, a bond market, a real estate market, or other types of financial securities.
Once you’ve identified some ETFs that pique your interest, you can use the following criteria to help you evaluate their investment potential.[alert-note]⇒ Investing Tip: Only buy ETFs from Top ETF Providers.[/alert-note]
The 3 Most Important Things to Consider When Buying an ETF
1. Low Expense Ratio
The annual fee that ETFs charge all their shareholders is known as the Expense Ratio, and this figure is expressed as a percentage.
The Expense Ratio includes the fund management fees we’ve already discussed, as well as other administrative fees and various fund operating costs.
Obviously, the lower an ETF’s Expense Ratio, the better it is for you, since it will translate into more money in your pocket at the end of every year.
For the best-case scenario, you should look for ETFs that offer an Expense Ratio of less than 0.30%.[alert-note]⇒ Investing Tip: Only invest in low-cost ETFs – Expense Ratio < 0.30%[/alert-note]
2. Strong Financial Performance
How can you evaluate an ETF’s potential for continuing to provide you with the best possible returns in the future?
The best way to determine a fund’s prospective financial performance is to confirm that it’s demonstrated good performance in the past. You can accomplish this by studying an ETF’s 3-year cumulative return.
Ideally speaking, this figure should be greater than 25% in order for you to enjoy annual returns of about 8%, but it goes without saying that the higher the ETF’s return, the better it will be for you over the long-term.[alert-note]⇒ Investing Tip: Only invest in ETFs that offer an annualized return of 8% or higher.[/alert-note]
3. Look for Top ETF Providers
It’s important that you only consider buying ETFs from the largest and most widely traded providers on the market.
These companies have already demonstrated their abilities as the most reliable investment sources, with the best financial performance, and their funds have been accurately built to match well-established stock market benchmarks.
Choosing a top ETF provider with a proven track record, rather than being tempted by the questionably high returns promised by an unknown fund company, will allow you to feel far more secure about exactly who you’re investing your money with.[alert-note]⇒ Investing Tip: Only buy ETFs from Top ETF Providers.[/alert-note]
How to Build a Diversified Portfolio
Diversification allows you to spread out your investment dollars over multiple areas, and it’s an important element in the success of every investment strategy for two very important reasons:
- It minimizes your financial risks
- It maximizes your financial returns
In order to build wealth effectively over the long-term, and to best protect yourself from financial mishaps, you must learn to think in terms of creating an investment portfolio that includes a variety of investment types.
For the best results, your portfolio should include:
- Exchange Traded Funds,
- Value stocks
- and Income stocks (such as REITs or dividend-paying stocks).
All of these investment vehicles are crucial components of a diversified portfolio, and while value and dividend stocks may bring you higher profits, you should never underestimate the importance of continuing to invest a significant portion of your money in ETFs.
As we’ve seen, ETF investing is an effective method in itself for diversifying your investment dollars, since it allows you to buy into and benefit from the established performance of an entire stock market, or a specific market sector.
Although ETF returns may be somewhat lower than some individual stocks, they also tend to be a little more stable and a little less subject to market volatility and price fluctuations.
Investing in value stocks will help your portfolio to grow at a much faster rate than it might otherwise, owning income stocks will allow you to build a desirable stream of passive income for yourself, and ETFs will go a long way toward bringing you a stable return over the long-term.
A portfolio that contains a mixed of ETFs, value stocks and income stocks will bring you a consistent long-term return.[alert-note]⇒ Investing Tip: An ideal portfolio should include ETFs, value stocks and income stocks.[/alert-note]
The Bottom Line
Investing in Exchange Traded Funds is quite simply one of the best ways for you to build your long-term wealth. Not only do they provide an effective way to diversify your investment holdings, by spreading your money across an industry group or an entire market, they are also one of the safest stock market investments since they help to reduce the unpredictability of your portfolio’s performance.
As a new ETF investor, the best way for you to enjoy the most successful results is to take the time to invest in your own education before investing in an actual fund.
Before you buy your first ETF, make a point of learning as much as you can about the Exchange Traded Fund investing approach.
You can start with the ETF provider websites referenced in this article, but don’t be afraid to search further afield for less biased content.
ETFs have become a common investment vehicle, and there is no shortage of information about them on financial websites, in business magazines, and in the literature provided by many investment and brokerage companies.
It’s often a good idea to try picking a few promising ETFs, and tracking their progress over a period of time. This exercise will not only provide you with a practical, ‘hands-on’ approach to learning more about how these funds perform and operate, it will also give you the opportunity to practice your ETF selection strategies before you invest any actual money.