Thinking about investing but not sure where to start? Exchange-traded funds, or ETFs, can be a great option for beginners. They’re a relatively straightforward investment vehicle that can offer impressive returns without requiring too much effort or expertise.
In this article, we’ll walk you through the basics of ETFs, including how they work and how to buy them. Whether you’re looking to start small or go big, read on to learn more about investing in ETFs.
What is an ETF?
ETFs, or exchange-traded funds, are a popular investment option that can help you diversify your portfolio without having to buy individual stocks or bonds. Think of it like a basket of investments that you can buy in one go.
For example, let’s say you’re interested in investing in the S&P 500, which is an index of the 500 largest publicly traded companies in the US. You could buy shares of an S&P 500 ETF, and your money would be used to invest in all 500 companies in that index.
ETFs can be a convenient way to invest in a diverse range of assets without having to buy each one individually. Plus, because ETFs are traded on an exchange like a stock, you can buy and sell shares throughout the trading day, just like you would with any other stock.
ETFs vs. Mutual Funds
If you’re wondering how exchange-traded funds (ETFs) differ from mutual funds, the answer is quite simple. It all boils down to how you buy and sell them.
With mutual funds, you typically invest a set dollar amount, and the price is calculated once per day. While you can buy mutual funds through a broker or directly from the issuer, the transaction is not instantaneous.
ETFs, on the other hand, work more like stocks. They trade on major exchanges such as the NYSE and Nasdaq and you can buy and sell them throughout the trading day.
Instead of investing a set dollar amount, you choose how many shares you want to purchase. Since ETFs trade like stocks, their prices are continuously fluctuating throughout the day, giving you more control over when and how much you invest.
Read more: How to Invest in Mutual Funds
Types of ETFs
Here are some of the most common types of ETFs that you might consider for your investment portfolio:
- Stock ETFs: invest primarily in stocks, providing exposure to different sectors such as technology, healthcare, or energy.
- Bond ETFs: invest in fixed-income securities, such as government bonds, corporate bonds, and high-yield bonds.
- Specialty ETFs: focus on a particular theme or sector, such as healthcare, technology, or real estate.
- Sustainable ETFs: invest in companies that meet certain sustainability criteria, such as having a low carbon footprint or promoting gender diversity.
- Commodity ETFs: invest in physical commodities, such as gold, oil, or agricultural products.
- Factor ETFs: invest in companies that meet certain quantitative criteria, such as having a low price-to-earnings ratio or a high dividend yield.
- Currency ETFs: invest in foreign currencies, such as the euro or the yen.
By including a mix of different types of ETFs in your investment portfolio, you can diversify your assets and potentially reduce risk.
How to Buy an ETF
Here’s how to identify the best ETFs for you, and how to buy them in just a few steps.
1. Open a brokerage account
Before you can start buying and selling ETFs (that’s exchange-traded funds, for the uninitiated), you’ll need a brokerage account. But don’t worry, it’s not as intimidating as it might sound. It’s basically like opening a bank account, but for investing.
If you’re not sure where to start, check out our resource on brokerage accounts and how to open one. You can do it all online, and many brokerages don’t have account minimums, transaction fees, or inactivity fees. So, you don’t need to be a Wall Street big shot to get in on the action.
But, if you’re more of a hands-off investor, a robo-advisor might be just what you need. These automated services build and manage investment portfolios for you, often using ETFs. The best part? It’s all done for a low annual fee, typically around 0.25% of your account balance.
Keep in mind that with a robo-advisor, you won’t be able to choose the specific ETFs you want to invest in. But hey, that’s kind of the point – they do the heavy lifting for you. So, if you’re looking for a more curated investment experience, a robo-advisor could be the way to go.
2. Choose your asset allocation
Now that you’ve got your brokerage account set up, it’s time to talk asset allocation. Don’t let the fancy term scare you – all it means is figuring out how much of each type of investment you want to make. This is key to making sure you reach your goals, so listen up.
Most people split their investments between two types of ETFs: bond ETFs and stock ETFs. Bond ETFs offer steady returns, but not a huge payout. Stock ETFs, on the other hand, can have some major swings in value, but also offer the potential for bigger rewards.
So, how do you decide how much of each to invest in? Well, one factor is your timeline. If you’ve got a long way to go until you need the money, you can afford to take more risks with stock ETFs. But if you’re closer to your goal, you might want to play it safe with more bond ETFs.
Another thing to consider is your comfort level with risk. If you’re the type of person who can’t sleep at night if you think you might lose money, you might want to go with a more conservative approach. Sure, you might need to contribute more money to reach your goals, but at least you’ll be able to rest easy.
Need some guidance on how much to invest in each type of ETF at different stages of life? T. Rowe Price has some recommendations:
- In your 20s and 30s: 90-100% stocks, 0-10% bonds
- In your 40s: 80-100% stocks, 0-20% bonds
- In your 50s: 65-85% stocks, 15-35% bonds
- In your 60s: 45-65% stocks, 30-50% bonds, 0-10% cash/cash-equivalents
- In your 70s and beyond: 30-50% stocks, 40-60% bonds, 0-20% cash/cash-equivalents
Remember, these are just suggestions – ultimately, you should choose an asset allocation that works for you and your goals.
3. Researching ETFs for your portfolio
You’ve got your asset allocation figured out, so now it’s time to find the ETFs that will help you reach your goals. Don’t worry, it’s not as intimidating as it might sound – your brokerage probably has some research tools that can help you out.
One of the things you’ll want to consider when choosing ETFs is the index they track. Most ETFs try to mimic the performance of an index, so you’ll want to make sure you’re choosing indexes that align with your asset allocation. For example, if you’re looking to invest in stocks, you might start with indexes like the S&P 500, NASDAQ, or Dow Jones Industrial Average.
If you’re interested in specific sectors, you can look for indexes that track those segments of the market, like large-cap, mid-cap, or small-cap companies, or international/emerging markets stocks. Just keep in mind that these may carry more risk than a broad index like the S&P 500, but they also might offer higher returns.
When it comes to the bond-based part of your portfolio, you’ll want to look for indexes like the Barclays Capital U.S. Aggregate Bond Index. For even less risk, consider indexes that focus on Treasury-backed securities. These are about as safe as investments come, thanks to the U.S. government’s history of paying its debts.
Another thing to keep in mind when choosing ETFs is their fees. ETFs are generally cheaper than actively managed funds, but you’ll still want to look for ones with low expense ratios. These can vary depending on the provider, so do your research. And make sure your brokerage lets you trade your chosen ETFs without any fees – every little bit helps!
4. Buy the ETFs
If you’re managing your own portfolio, you’ll need to know how to buy the ETFs you want. Don’t worry, it’s pretty straightforward – it’s kind of like buying a stock.
First things first, you’ll need to fund your brokerage account. Just transfer some cash in and you’re good to go.
Next, you’ll need to search for the ETF ticker symbol. Your brokerage might have a tool that lets you buy shares directly from the ETF’s entry, but if not, just head to the trade section of the brokerage and enter the ticker symbol.
Once you’ve found the ETF you want, you’ll need to enter the number of shares you want to buy. Keep in mind that you can’t usually buy fractional shares of ETFs, so you may not be able to invest all of the money you have ready to go. But don’t worry, you can always invest the rest later.
Last but not least, you’ll need to confirm your order. In most cases, you’ll do what’s called a “market order.” This means your purchase request will go through at the current price of the ETF, instead of waiting for a specific price.
5. Set Up Your Purchase Plan
You’re not just in it for a quick buck – you’re in it for the long haul. That means buying ETFs on a regular basis to help you reach your goals. And don’t worry, most brokerages make it easy to set up a purchase plan.
Here’s how it works: just arrange for a set amount of money to be moved from your checking account into your investment account on a regular basis. Then, tell your brokerage to buy as many ETF shares as possible with the money you have in your account. This strategy is known as dollar-cost averaging, and it can help you pay less per share over time.
While you’re setting up your purchase plan, think about how often you want to check in on your portfolio. Most experts recommend taking a look every six to 12 months to make sure your asset allocation hasn’t shifted too much. If it has, you might want to buy and sell certain investments to get back to your desired level of risk.
If all that sounds like too much work, don’t worry – a robo-advisor can take care of it for you. They’ll automatically rebalance your portfolio as needed to keep you on track.
FAQs
What is the difference between an ETF and a stock?
When you buy a stock, you’re investing in one particular company. ETFs, on the other hand, invest in a diversified range of assets, such as stocks, bonds, and commodities. This means that by investing in an ETF, you’re spreading your money across a range of assets, providing you with a simple way to diversify your portfolio.
Are ETFs safer than individual stocks?
ETFs can be a safer option than investing in individual stocks, particularly if you choose a well-diversified ETF. If some of the stocks within the ETF don’t perform well, the other holdings can offset the losses, reducing your overall risk.
Do ETFs pay dividends?
Some ETFs pay dividends, but it depends on the specific ETF and the stocks it holds. If you’re interested in using dividends as part of your investment strategy, consider looking for ETFs that hold dividend-paying stocks or focus on dividend aristocrats – companies with a history of regularly increasing their dividend payments.
Are ETFs suitable for beginners?
Yes, ETFs can be a great option for beginners. They’re relatively inexpensive, widely available through robo-advisors and traditional brokerages, and less risky than investing in individual stocks. Robo-advisors are online investment advisors that can help you build and manage a portfolio, often using ETFs because of their low cost.
