For beginners, ETFs can be an easy way to start the journey of investment where one can get outstanding outcomes with comparatively little effort and expense. Here we will discuss how to begin investing in ETFs.
In exchange-traded funds, one can buy many stocks and bonds at a time. The difference between the Index funds and ETF lies in the trade timing. ETF trade the whole day whereas the Index funds trade only once at the end of the day. ETFs are more tax-efficient than the mutual funds and can be bought commission-free and in that case, it is cheaper than the index fund.
Passive ETFs usually track an index like the S&P 500 index that tries to match the index performance. Whereas in the active ETFs, investment managers are continuously managing the portfolio through buying and selling to beat the market. To understand ETFs further, we will have to understand some basic terminologies.
It is the amount that a company annually charges the investor in order to manage the portfolio. The expense ratio for ETFs is typically lower than the mutual funds, that’s because the ETFs are passively managed. The average expense ratio for actively managed funds is around 0.5% to 1.0% and for passively managed, i.e ETFs it is 0.2%.
Dividends are the amount of money paid to the shareholders out of the company’s earnings as a reward for investing the money. The investor can either transact that money in the form of cash or can choose to reinvest through his brokerage account.
There is no idea of the minimum investment amount in ETFs. To get started, the investor has to buy at least one share on the current market rate, which gives the idea of the minimum amount of investment required in ETFs.
Compared to mutual funds, let’s see the advantages and disadvantages of ETFs.
Pros of investing in ETFs
ETFs are more cost-efficient as they are passively managed. As mutual funds are actively managed so all the service fees collectively increase the burden on the investor.
- ETFs provide an easy diversification. Even a single share can provide the investor with exposure to a variety of globally developed companies.
- ETFs can be started with relatively lower investment as compared to mutual funds. You can start with the current market rate of a share you choose and that can be as little as $500. That is surely not the case in mutual funds that would need to invest like several thousand dollars to get started.
Cons of investing in ETFs
ETFs are managed at low costs, but they are not free. As compared to the ETFs if you buy an individual stock portfolio can be bought absolutely free of cost.
- The big positive feature of ETFs is their diversification that is helpful against the potential risks. But their average returns are much lower than buying the individual stocks.
- ETFs have limitations when it comes to avoiding or selecting a particular company. When an investor selects a particular index, then he is bound to go with the companies under that index despite the moral or any other conflict the investor may have with a particular company under that index.
Opening a brokerage account
You will need a brokerage account before going for investment. You can choose between an Individual retirement account (IRA) or a regular taxable account depending on your style of investing. For a newbie we strongly recommend you look for a broker who offers research and education features that can be helpful to you growing as an investor. The opening process can be done 100% online without any transaction or inactivity fees.
Choosing your first ETF
Now you have to decide the ETF you have to buy. It’s important that you go through the performance history of the ETF. As a beginner generally the passively managed index funds are the safe options as they just have to match the market performance. Index funds are cheaper to get started too. Also, the actively managed funds fail to beat the index, hence the investor can get into trouble.
To start from scratch there are many ETFs that are suitable to build up the portfolios. Here is a brief list of some of them with their brief descriptions.
1. Vanguard S&P 500 ETF –Includes the 500 large companies of the U.S stock.
2. Schwab U.S. Mid-Cap ETF – Includes the mid-sized U.S companies.
3. Schwab U.S REIT ETF—Includes real estate investment funds.
4. Vanguard High-Dividend ETF—Includes stocks that offer exceptional dividends to their shareholders.
Vanguard and Schwab are known for their convenient policies for new investors’ access to the stock market. ETFs from both of the companies offer cheaper expenses so are preferable to the new investors.
Relax and wait for the returns
Now as you have successfully brought your first ETF. Your investment can help as the first step in forming a diversified portfolio. You don’t have to check the performance of the ETF and get freaked out if the market is underperforming.
The market is volatile in its trends and the newbies have the potential behavior of getting frustrated over it. You just have to sit back binding your hopes with the long term growth.